Trader’s Narrative

Today the Bank of Canada decided to maintain their historically low interest rates at 0.25% but they did sound cautiously optimistic:

Recent indicators point to the start of a global recovery from a deep, synchronous recession. Global economic and financial developments have been somewhat more favourable than expected at the time of the July Monetary Policy Report (MPR), although significant fragilities remain.

A recovery in economic activity is also under way in Canada. This resumption of growth is supported by monetary and fiscal stimulus, increased household wealth, improving financial conditions, higher commodity prices, and stronger business and consumer confidence. However, heightened volatility and persistent strength in the Canadian dollar are working to slow growth and subdue inflation pressures. The current strength in the dollar is expected, over time, to more than fully offset the favourable developments since July.

Source: Bank of Canada

Unlike Australia, who has already started ended their easing cycle, they believe that inflation is not a danger and won’t be for the foreseeable future. Not only is it being kept in check by the frail economic recovery, the annoyingly strong Canadian dollar promises to keep a lid on it, if it does creep up.

Add to that the intoxicating cocktail of a commodity based economy, a strong real estate market (see below), strong fiscal discipline, and a famed (and quite boring) political stability that rivals Switzerland and you have the makings of a love affair:

One of the main reasons for our resilience has been the health of our real estate markets. I must confess that I was surprised to see the subdued reaction of the Canadian real estate market to the crash of its US counter part. After all, the two economies are intertwined like no other two countries in the world. However, for all our inter-dependence, there are significant differences. Canadian bankers never quite got the hang of laughing in the face of infinite risk or perhaps our regulators have yet to be so completely and embarrassingly captured as they are in the US.

Whatever the root cause, the Canadian real estate market has bounced back after a very late and shallow decline. As well, while our mortgages do default, the rate is extremely low and has barely experienced an uptick worthy of note:

Source: Globe & Mail

Canadian REITs gave long term investors quite a scare late last year as they were dumped along with everything else. However, while their price may have declined, their value continued to be very attractive. When I featured RioCan (REI.un) in November 2008 it was trading at $13 Cdn and yielding 10% - since then it has risen to $18 Cdn - and that’s not even considering all those juicy monthly distributions.

Meanwhile, Canadian equities have risen 27.3% in 2009 and slightly over 50% since their spring lows. But here’s the curious thing. While most major stock markets around the world have recovered from their shallow retracement in late September and gone on to newer highs for the year, the Canadian S&P/TSX index has not. That non-confirmation is slightly unnerving, especially when you consider just how much the Canadian equity markets have going for them.

About 4 months ago I wrote about the Canadian stock markets with a dual message: the Canadian retail investor was panicking and cashing in their mutual fund. According to contrarian analysis, this is a good thing because the less knowledgeable and weaker market participants are usually wrong - especially when they react like a herd.

But I also wrote “Caution, Caution, Caution”, saying that even so, I was worried that the market looked heavy. My reasoning was based on the percentage of stocks above their moving average.

My thinking was that although the sentiment would probably put a floor on the market, things could get a bit dicey. Did they ever!

In this case, it pays to be lucky! I was right in being cautious but wrong in thinking that the market would soon rebound from any weakness. After falling, the index has been wrapped up in a tight trading range for the past two months. To be honest, it shocked me to see it so weak in the aftermath of the July sell off.

I wanted to layout my thinking to illustrate that relying on any one indicator, however sound or logical it may be, is dangerous. Timing the stock market is an extremely difficult thing to do and if you’re going to get lucky, it pays to have many tools in your toolbox.