Don't Get Your Hopes Up

02/01/2010 12:01 am EST

Focus: GLOBAL

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

The Canadian market may not move decisively higher until the fall, as it handicaps risks to the recovery, writes Gordon Pape in the Internet Wealth Builder.

It looks like the correction I have been expecting for some time is finally upon us. It took longer to develop than I thought, but now the slide seems to be gaining momentum. The S&P/TSX Composite Index lost 420 points in three trading sessions [the week before last and was] down 7% from its 2010 high of 12,070 reached in intra-day trading on January 1th1 [before Friday’s bounce]. That doesn't make it a full-fledged correction yet (the generally accepted criterion is a decline of at least 10%), but another week like the last one could do it.

The pull-back should come as no surprise. The rebound in stocks from their March lows was amazingly strong, especially in the context of a still fragile economic recovery. Sooner or later, investors were going to pause and take some of their profits off the table.

Once the current slide ends, I expect we'll move into a period of several months when the markets show little sustained momentum one way or the other. We'll continue to see volatility, with triple-digit moves occasionally. But overall direction will be lacking until three things happen:

1. We get stronger evidence that the economic recovery is not only under way but is gaining traction that will carry it into 2011. So far, there has been very little to get excited about. The Bank of Canada said last week that the country is on track for stronger growth in the second half of this year and through the first part of 2011. But the Bank stressed that the global economy is still heavily dependent on government stimulus measures and that private sector demand may take longer than expected to materialize.

2. Profits improve. We're still early in the earnings season but the results to date have not exactly inspired confidence. Alcoa (NYSE: AA), which is always first out of the gate with its financials, disappointed analysts and some of the big US banks reported heavy losses. There have been bright spots, such as Intel (Nasdaq: INTC) and Google (Nasdaq: GOOG), but no clear pattern is apparent yet.

3. The interest rate picture comes into focus. Speculation is rampant as to when major central banks will start to tighten and by how much. After the Bank of Canada report came out, one prominent Canadian bank economist said he expected our interest rates to start moving higher as early as July. At almost the same time, his counterpart at another bank predicted we would not see any hike until the fourth quarter. That kind of uncertainty puts a chill on both stock and bond markets.

It could be fall before we see the next strong up-leg in this market. That doesn't mean there won't be profit opportunities before then. But selectivity will be the key to success.

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