I could write a very, very long list of pessimistic facts that will act as ‘headwinds’ to positive stock market performance. However, this long list (especially as it relates to the economy) will be triumphed with time by two large positive factors:

1. Stocks have dropped significantly from their respective highs and they are frequently trading at a price to earnings ratio of 10 or less (the inverse being the earning yield of 10%). This means if nothing changes the book value (sometimes referred to as replacement value) of the business, it is growing at 10% per year. In short, stocks are cheap and they don’t have to do much in order to generate some positive returns. In fact, Caterpillar announced earnings this morning and they missed expectations by 2 cents per share. They discussed various negative factors affecting the business and yet the stock is up 6% in Europe. In the past, this would have resulted in big losses in the stock but investors have significantly reduced their current expectations;
2. The Central Banks have demonstrated a willingness to do almost anything to unlock ‘thawed’ or frozen credit markets and get banks lending again (money in motion is a prerequisite to a healthy economy). On October 9^th I became very ‘concerned’ that Central Banks were ‘silent’ on the solution but since the G-7 finance ministers met on Thanksgiving weekend (October 11^th) we have seen a material change in their conduct. We have also seen how quickly they are willing to deploy capital in a coordinated and consistent manner. These actions are paying off as we see LIBOR rates dropping to pre-Lehman Bankruptcy levels (the Lehman bankruptcy was the key catalyst that caused credit markets to freeze up). LIBOR or London Intra Bank Offertory Rate is the key global measure of the cost of companies to borrow money from the bank and the cost of banks lending money to other banks. LIBOR has dropped more than 1% in the last 2 days (that is a big deal and equity markets are reacting to that news big time)! In addition, we might see another stimulus package from the U.S. Congress later this year (more on that in a minute).

I also highlighted earlier that Warren Buffet has written an article in the New York Times publicly stating that he is bullish on stocks (especially U.S.) stocks. What is interesting to note is that he has only publicly stated twice in his career that he is bullish on stocks. Followers of Warren Buffet will know that he is not a market timer nor does he comment on the market – a true stock picker.

The 1^st time came in 1974 when he said, “I feel like an oversexed man in a harem. This is the time to start investing.” The Dow Jones Industrial Average gained almost 100% in the next two years (it is also interesting to note that the last time the Dow dropped by more than 40% was in 1972). The 2^nd time came in 1979, when he told Forbes Magazine that “stocks now sell at levels that should produce long-term returns far superior to bonds.” That prediction also proved to be correct. His last ‘call’ came last Friday. Only time will tell if he is correct for the 3^rd time in his career although, one could argue that he rarely makes a call. I would argue that Warren only makes a call when stocks are uncharacteristically ‘cheap’ and things have rarely been this ‘cheap’. In addition, Warren also admits that he (nor anyone) else knows the short-term direction of stocks but over the long-term, fundamentals will prevail.

Yesterday, we experienced a broad rally in stock markets led by North American stock markets with energy, materials and financials leading the way (stocks were up between 4.5 to 6+% but energy was up more than 10%). At an emergency meeting later this week, OPEC is rumored to be cutting oil production by more than 2 million barrels per day which is pushing oil prices up. I would expect some profits taking in the near term as oil prices start inching back up to $80 per barrel from the current $74 per barrel.

In the short-term there will be no shortage of ‘things to worry about’. Not all companies will achieve their respective earnings targets and there will be signs of investor anxiety and concerns over corporate earnings. Texas Instruments also reported earnings this morning and they failed to impress. TI has long been considered a leading indicator to the overall health of the technology sector and some negative reports on RIM yesterday pushed their shares lower. Things will continue to be volatile since the Chicago Board of Options Exchange (CBOE) VIX index (measure of fear or volatility) is still trading above 50 but off its historic high of more than 81 set last week. That is a very material change but 50 is still very, very high and thus, investors are still expecting big price swings in either direction in the short-term.

In the U.S., stocks gained as Congress and the current Bush Administration moved toward approving or defining a 2^nd stimulus bill or package this year (the 1^st was $168 billion in tax rebates). This came after Federal Reserve (Fed) Chairman Ben S. Bernanke endorsed the idea and the Bush administration dropped its opposition (running higher short-term deficits in order to avoid long-term financial pain).

Wilfred Vos Bcs, CFP, FMA, FCSI, CIM, CFA, MBA, DMS, CBV

SVP & Partner