Wareham Weekly Insights

The big picture
U.S. manufacturing grows amid rising unemployment

Showing unexpected strength, the U.S. manufacturing sector grew in October at its fastest pace since April 2006, suggesting U.S. gross domestic product is growing at an annualized rate of 4.5% in the fourth quarter. The manufacturing index rose for the third consecutive month in October after 18 consecutive months of contractions. The services sector grew for a second straight month in October, but at a slower pace than in September. Despite this growth, the unemployment rate rose to 10.2% in October, the highest since April 1983, with the largest job losses in construction, manufacturing and retail.

The Bank of Canada (BoC) is still predicting growth in the second half of 2009, even though recent GDP data indicated that the economy contracted in the third quarter. The BoC predicts the economy will grow 3.0% in 2010 and 3.3% in 2011. Finance Minister Jim Flaherty said on Monday that Canadians should not expect the employment market to recover as quickly as the general economy. “The recovery in jobs will lag recovery of the economy. That is to be expected. That is the lesson of past recessions. It takes time for businesses to regain confidence, to reinvest in their businesses and thereby create jobs.” Canada's unemployment rate rose to 8.6% in October from 8.4% a month earlier as the economy shed 60,000 part-time jobs. Full-time employment increased slightly.

Markets
Stocks rally; GM does a U-turn

The TSX surged this week as gold prices reached a record US$1,101 after a pledge from the Federal Reserve to keep interest rates low weakened the U.S. dollar, and billionaire Warren Buffett bet big on the U.S economic recovery. North American markets also rallied on strong U.S. manufacturing data and better-than-expected earnings by technology bellwether Cisco, although the TSX was hit by surprise losses from Sun Life and Manulife.

General Motors did a U-turn, scrapping plans to sell Opel to Canadian auto parts supplier Magna. Unions are seething as GM Europe will now revert to a reorganization plan that chops fixed costs at Opel by 30%. Enbridge reported third-quarter profit more than doubled to $300 million versus one year ago. Warren Buffett will make his biggest ever investment, buying Burlington Northern Santa Fe Railway for US$44 billion in what the billionaire described as “an all-in wager on the economic future of the United States.” BlackBerry maker Research In Motion fell more than 6% on Monday after an analyst told investors to sell the stock because of mounting competition and an influx of new phones and applications.

Our recommendation
Favour equities over bonds
· Equities. Stephen Uzielli, Portfolio Manager, Portfolio Advisory Group, says the current pullback in equity markets is one of what will likely be a series of retracements in the coming months, but which will likely be shallow and short-lived, thus creating a buying opportunity for investors who have not yet made their full equity allocation. Buy the dips.
· Fixed income. Anthony Mentor, Associate, Portfolio Advisory Group, highlights the following recommendations: Term Call – below benchmark duration. Sector Call – underweight Canadas, overweight Municipals and Provincials, neutral on Corporates. Currency Call – recent weakness in the Canadian dollar means little upside to foreign currency trades. Alternative Strategies – overweight high yield, overweight Emerging Markets Debt, underweight inflation protected bonds.
· Portfolio strategy. Vincent Delisle, Scotia Capital’s Portfolio Strategist, writes, “Based on our 2010 forecasts, equities (10%-12%) should outperform government bonds (0%) and high yield (4%-6%) over the next 12 months. We are sticking to our equity overweight bias, but our current asset mix recommendation is as cyclical as it will get.”




The month in review
October: Surges and setbacks on climb to recovery
Facing mixed economic data, investors were sometimes unsure which way the economy was headed in October. While the U.S. economy showed surprising GDP growth, unemployment continued to climb. In Canada, where jobs were growing, GDP contracted. In the U.S., high unemployment continues to hamper consumer spending, which accounts for 70% of U.S. economic activity, and Americans will need to cut back after years of accumulating too much debt, according to U.S. Treasury Secretary Timothy Geithner, who warned that the whole world will need to reduce their dependence on U.S. consumption.

U.S. GDP grows while Canada contracts
The Commerce Department reported that U.S. GDP expanded at an annual rate of 3.5%, an unexpected surge after the economy had contracted 0.7% and 6.4% in the second and first quarters, respectively. Robust government spending, exports, and consumer spending – lifted by auto purchases under the cash-for-clunkers program – pushed the measure into positive territory. In contrast, Canada’s GDP shrank 0.1% in August despite signs that the country is climbing out of recession.

Jobless rate falls in Canada, climbs in U.S.
Canada’s unemployment rate fell to 8.4% from 8.7% in September, the first monthly decline since the fall of 2008. Employment increased for the second consecutive month, up 31,000. In the U.S., unemployment is at a 26-year high of 9.8% and still climbing.

Australia and Norway increase rates; Canada and U.S. on hold
Australia became the first among the Group of 20 countries to increase borrowing costs since the start of the global financial crisis, and Norway the first country to raise rates in Europe. The Bank of Canada announced it would keep its key rate unchanged at a record low of 0.25% and U.S. policymakers agreed that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

Rollercoaster month for Canadian dollar
The Canadian dollar was volatile, fluctuating over a five-cent range during October. The loonie approached parity, topping 97 cents U.S. mid-month before falling back. Prime Minister Stephen Harper warned that too rapid a rise could damage the country’s economic recovery, but said some of the Canadian dollar’s sharp climb is justified by fundamentals. The central bank has said it will not counteract rises in the dollar due to fundamental factors.

Oil and gold reach highs
In mid-October, gold hit a record US$1,070 and its popularity has risen to the point where shoppers can now buy gold bars at Harrods department store. In the third week of October, oil reached a fresh 2009 high of US$81.36 a barrel.

Dow breaks 10,000 and falls back
The blue-chip Dow index broke through the psychologically important 10,000 mark, up 52% up from its March low but still 29% below its peak in October 2007. Despite a strong start, North American markets ended the month down as commodity prices weakened and bleak U.S. home sales data caused stocks to slide.

Smart phone wars rage on
Nokia filed a lawsuit claiming the iPhone infringes 10 of its patents and Research In Motion rolled out an updated BlackBerry Bold in an effort to fend off Apple’s gains in the cellphone market. Bell and Telus will break Rogers’ monopoly and begin selling iPhones in November as their new iPhone-compatible network comes online. Verizon will offer phones with Google’s Android operating system, while Microsoft unveiled its own new mobile operating system, available on 30 phones.


Privacy Policy and Legal DisclaimerTM Trademarks used under authorization and control of The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member CIPFThis publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of ScotiaMcLeod, a division of Scotia Capital Inc. ("SCI"), but the data selection, analysis and views expressed herein are solely those of the author and not those of SCI. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor SCI can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your investment advisor, who can assess all relevant particulars of any proposed investment or transaction. SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice. All performance data represents past performance and is not indicative of future performance. Scotia Capital Inc. and its affiliates collectively beneficially own in excess of 1% of one or more classes of the issued and outstanding equity securities of Royal Bank. Within the last 12 months, Scotia Capital Inc. and/or its affiliates have undertaken an underwriting liability with respect to equity or debt securities of, or have provided advice for a fee with respect to Royal Bank. TM Trademark used under authorization and control of The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member CIPF.