In with the new and out with the old

It was a tough year for the world equity markets in 2000. Most of the volatility stemmed from the fact that the technology sector was highly over-priced due to the euphoria of investors hoping for the next big payoff. Late in the year, earnings came out softer than expected and the North American economy was under some inflationary pressures and in retrospect, it was easy to see why markets took a step backward.

Unfortunately, it is always easier to see things and rationalize them after they have already happened. I only wish I had the ability and foresight to see to future and where equity markets are going. That being said, I hope that 2001 will be a good year for equity markets. History has taught us that markets tend to rebound after a tough year but that is just not good enough justification for strong equity markets in 2001.

Here are some thoughts for what we need to see to have stronger equity markets around the world this coming year:

  • Low-Interest Rates – As long as we do not see inflation force interest rates to go substantially higher (particularly in North America), we should see stronger markets. Every time there is talk of rising interest rates, markets tend to react negatively. Low inflation and low-interest rates are the ideal environments for strong equity markets.
  • Investor Sentiment – As investors get their year-end statements, some will be disappointed with their annual results. While logic tells us that when prices drop, we should buy, emotion causes us to react in the opposite manner. A tough year in the markets will have an adverse effect on peoples investing behavior. Markets need investor confidence to move ahead. This is especially true in areas like Japan and the Far East.
  • Governments and Fiscal Responsibility – In Canada, we have seen how markets react to government fiscal policies. Governments are no different than individuals, in that you must have your fiscal finances in healthy shape. Governments with too much debt and too much spending will eventually have currency and economic problems. It is important to have good fundamentals at home for a healthy market environment.
  • Corporate Profitability – Never have I seen markets that react so adamantly to the news on corporate earnings and profits. The expectation of stock market prices is largely determined by the profitability of individual companies. More profits mean higher prices and higher expectations of prices.

Think of these factors as four engines on an airplane. If you have four engines working for you (low-interest rates and inflation, strong investor sentiment, productive government policies, and strong corporate profitability), then you will have a very strong market environment for 2001. On the other hand, if there are no engines working on a four-engine airplane, you are in for big trouble. Finally, having 2 or three engines working is not too bad. You can stay in the air, susceptible to turbulence, and even see some elevation but managing your expectation of return is most important.

While this is not an exhaustive list of what will provide stronger markets in 2001, it represents some key engines that will fuel future market growth.

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