Charting New Territory

If one had to sum up market events in 2009 with one word, “unprecedented” is what comes to mind.

At the outset of the year, things could not have looked worse for investors. The economy was reeling from the near collapse of the global financial system. And despite government intervention in the US and Europe, not to mention an “unprecedented” coordination of efforts among central banks, stock markets around the world were in free fall. The fear was palpable. Then in mid-March, the trend abruptly reversed as stocks began an extended rally that continued through to the end of the year. In Canada, the TSX climbed from the lows set in March by almost 60%, an “unprecedented” rise over such a short period of time. As a result, our benchmark index ended the year with a total annual gain of 31%. Elsewhere, the story was similar. South of the border, the S&P 500 rose 23% over the year and the MSCI world index gained 32%. (Source: The National Post, January 2, 2010)

We still have a ways to go to recapture all the lost ground during the financial crisis. But, it is fair to say that no one expected markets to come back this far this fast.

The Financial Crisis One Year Later

Given the strength of the market rebound, one might be tempted to believe the financial crisis is over and done with. Or worse yet, with the size of 2009 bonuses on Wall Street, one might even think the crisis never happened! But of course, the reality is far different. At this stage, the situation has stabilized and banks are lending money again. That much is a relief. But the financial system is still very fragile as evidenced by the after shocks we have already experienced in Iceland, Greece and now more recently in Dubai. On the longer term, to adequately repair the global financial system, there are significant regulatory issues that still need to be addressed at the national level as well as internationally. This is no easy task. In the US and Europe, policy makers are discussing important reforms to the regulation of their financial systems. But progress has been slow, politics being what they are. As for the global village, the idea of implanting a coherent set of rules to regulate the international flow of capital is but a dream at this point.

Suffice it to say, there are still significant challenges ahead. For now, thanks to massive monetary and fiscal stimulus, the markets are rebounding and the economy has regained some vigor. What remains to be seen is the extent to which the economy will be able to start functioning well enough for a sustained recovery.

Economic Recovery and Market Outlook

Normally in the wake of a severe recession, economic growth is quite vigorous. This time however, the recovery is clouded with uncertainty on big, competing issues like unemployment, interest rates and inflation, not to mention ballooning sovereign debt. Government rescue plans and massive fiscal stimulus deployed during the financial crisis have translated into “unprecedented” debt to GDP ratios in some countries. In Canada, the ratio of our national debt to GDP is expected to climb from 25 to 35%. That is manageable, but elsewhere, the national debt is over 100% of GDP! All that red ink is going to be hard to erase and inevitably, we will see higher levels of taxation down the road. (Source: Don Drummond, TD Financial Group,The National Post, January 7, 2010) Then there is the question of interest rates which are now rock bottom by historical standards. At one point, central banks will want to take the economy off this other form of artificial life support in order to control potential inflation. But that too will inevitably act as a drag on economic growth. And without robust economic growth, the jobs lost in the recession will be harder to replace. For now, the expectation is that central bankers will allow for some inflation in the short term, in order to keep interest rates low as long as possible.

In sum, even if we are spared more significant after shocks to the financial crisis, the economy has some tough sledding ahead. The good news, at this juncture, is that the majority of economists are predicting a sustained economic recovery going into 2010, albeit with somewhat tepid growth rates of 2-3 % for Canada and the US. (Source: Investment Executive, January, 2010)

For investors, this means caution remains de rigueur, despite the amazing market turn around of the last 10 months. With only a modest economic recovery in hand, we can expect stocks to continue to rebound over the next year, but at a much slower pace than in 2009.

The Decade Ahead

In the aftermath of the financial crisis, it seems we are not only setting new precedents, we are effectively chartering new territory. There will be many challenges along the way and we all need to be prepared for that. Big transitions are never easy. What is heartening is the fact that the financial system and the overall financial culture are now evolving for the better, albeit incrementally. If we consider that it took decades to create the problems that led to the crisis, it is perhaps not so unreasonable that it should take years to successfully rebuild a stronger, more sustainable global financial system. In my last year-end letter, I talked about the casino mentality that permeates our financial culture and the role it played in the financial crisis. This was something which struck a strong cord with many of you, so you will be encouraged to know that here too the winds of change are blowing. The public outcry over the latest round of bonuses paid to Wall Street bankers is a significant sign of things to come. The very successful Say on Pay campaign, spear-headed by Meritas Mutual funds, is another. (For more on this see www.meritas.ca)

Al in all, I expect we are in for a very interesting decade to come! Just remember, in this ever-changing world of ours, we have only to keep sight of the timeless wisdom that is the foundation of financial success and true prosperity.

Sara Gooderham
January 2010

Disclaimer from PEAK Securities Inc.: The information contained herein was prepared by Sara Gooderham, an Investment Advisor with PEAK Securities. This information has been obtained from sources we believe are reliable but is not guaranteed and may be incomplete. The opinions expressed herein do not necessarily reflect those of PEAK Securities. PEAK Securities is a member of the Canadian Investment Protection Fund (CIPF).