At the year's halfway mark, investors are facing a wall of worries.
There is the risk that heavily indebted Greece, or some other sovereign borrower, will be unable to pay its bills. The list of potential trouble spots even includes the U.S. government, which could technically default on its bonds come Aug. 2 if lawmakers don't pass an increase in the country's debt ceiling.
Adding to the problems, the global economy seems to have recently entered a soft patch, and the U.S. Federal Reserve Board, the world's pump-primer of last resort, is resisting the temptation to dump money into the financial system in a bid to boost growth. The second round of its quantitative easing program - so-called QE2 - concluded at the end of June and the central bank has given no hint that it will embark on another burst of stimulus.
The daunting list of concerns would seem to suggest that investors will be hard pressed to make money in the months ahead. But after a string of increases on the Dow Jones industrial average this week, things might be looking up. In fact, many market pros are sanguine or even a tad optimistic.
"What we're going through … is challenging and sometimes a little scary," admits Thomas Caldwell, one of the optimists. But Mr. Caldwell, CEO of Caldwell Securities Ltd., predicts "this is going to be an up year" with gains of as much as 10 per cent this year for Canadian stocks.
A rise of that magnitude would be a welcome change from the market's performance during the first half of this year. The S&P/TSX composite index is off 1 per cent year-to-date, but down a more substantial 7 per cent from the high of 14,270 it reached in April, just before May's sell off in commodity markets.
U.S. shares have outperformed Canadian equities by a wide margin over that period. The Dow Jones is up about 8 per cent year-to-date, while the S&P 500, a basket of large capitalization U.S. companies, has gained about 6 per cent.
Market sentiment on both sides of the border has swung between pessimism and optimism, as investors balance potential dangers, such as a Greek default, against the reality of surprisingly strong corporate earnings.
In the eyes of several market pros, there are now grounds for optimism. Interest rates, for instance, have come down substantially from their peaks in February, with the yield on 10-year U.S. Treasuries falling by about 60 basis points. (A basis point is one hundredth of a percentage point.)
Mr. Caldwell says U.S. interest rates are key because they remain at "ridiculously low" levels. Rock-bottom rates stimulate the economy by keeping down the cost of borrowing on mortgages and car loans. Low rates also lead investors to value corporate earnings and dividends more highly, a favourable factor for driving equities higher.
While Congressional wrangling over lifting the U.S. debt ceiling remains a concern, Mr. Caldwell is convinced that much of the fighting is political posturing. He expects both sides to compromise to prevent a default. "We have reasons for some degree of optimism," he says.
Mr. Caldwell, who favours buying Canadian energy, financial and materials stocks, has been using the recent weakness in share prices to pick up stocks he thinks are bargains, such as uranium miner Cameco Corp. He's also been buying shares in some beaten-down U.S. banks, such as Citigroup and Bank of America .
To be sure, a decent outcome for stocks depends on the economy's ability to avoid a recession. Most observers, though, don't believe a downturn is likely over the next few months - at least, barring a major mistake by policy-makers.
"Our view is that we're currently in a soft patch in the economy, but we don't foresee going into a double dip unless it's induced by something emanating out of Europe, particularly a debt default out of Greece," says David Andrews, director of investment management and research at Richardson GMP Ltd.
Looking at the tea leaves, Mr. Andrews sees bullish signs, among them the recent declines in the price of oil and other commodities. Although falling prices aren't good for commodity producers, they will help consumers maintain their spending levels - a plus for the broader economy - and take some of the upward pressure off inflation.
Mr. Andrews cautions that stocks could tread water for a while because of concern about the European sovereign debt situation and jitters over the Aug. 2 deadline for the U.S. to raise its debt ceiling.
Given these uncertainties, Mr. Andrews recommends a play-it-safe approach that favours high dividend plays such as telecom stocks and utilities.
"We're pretty comfortable telling clients that if you are putting money in the equity markets to have a defensive bias," he said.
To be sure, not everyone is bullish. Capital Economics expects the S&P 500 to drop back to 1,200 by the end of the year as QE2 stimulus fades and corporate earnings return to more normal levels. It warns that stocks look expensive by historical standards.
Eric Sprott, CEO of money manager Sprott Asset Management, says markets remain vulnerable to sudden downdrafts because the financial crisis that erupted in 2008 "has never been resolved."
Mr. Sprott, a prominent market bear and gold investor, is worried by the high degree of leverage in the banking system. He believes that banks as a group don't have enough capital to absorb setbacks, even if losses amount to as little as 5 per cent of their loans. He suggests that any periods of economic distress will cause policy makers and central banks to print money to ensure that financial institutions remain solvent.
Given this view, Mr. Sprott favours gold and precious metal miners over the market as a whole, saying he's "absolutely convinced" that prices for investments linked to bullion will move higher as the public seeks the safety of hard assets to protect the value of its money.