As the first half of the year draws to a close, stock investors are feeling shell-shocked.
Six months of thrills and spills ended Friday in a bounce that propelled stock markets around the world to big gains and shot oil prices more than 9-per-cent higher. The Toronto stock market surged 1.5 per cent and the S&P 500 jumped 2.5 per cent on the back of encouraging developments in the European financial crisis.
The high spirits on display were in stark contrast to the miserable mood of the past few weeks, when worry over slowing growth in the U.S. and China, and fear that the euro might implode, dragged down stocks.
More volatility looms as investors weigh relatively cheap valuations for many stocks against a slowing world economy and the potential for a euro zone blow up. Stock valuations look tantalizing compared to paltry bond yields, but pervasive uncertainty about global growth argues strongly for caution.
Many exchanges are sporting gains for the year, but practically all the upside occurred in a powerful advance that sputtered out by early March. The move upward was prompted by a massive injection of liquidity into the market by the European Central Bank, a manoeuvre that appears to have had little lasting impact.
The Toronto market is off 3 per cent for the year, although that small percentage decline masks huge volatility. Canadian stocks rallied strongly in January and February, but are now down about 9 per cent from the high of 12,740 that the S&P TSX composite index touched on Feb. 28.
"The stock market has been ratty, and for good reasons," comments Thomas Caldwell, CEO of Caldwell Securities in Toronto.
Mr. Caldwell cited worries over the U.S. economy and European debt situation as key factors hanging over stocks.
Investors' search for havens from the economic storm has produced an intriguing list of first-half winners and losers. In Canadian dollar terms, both the technology-heavy Nasdaq and Mexico's key index gained nearly 12 per cent. But Spanish stocks lost more than 19 per cent while Brazil's Bovespa, once an emerging market darling, tumbled nearly 12 per cent.
Given that the Canadian market is among the laggards and that Canadian corporate profits have held up well, some analysts say valuations here have reached levels that should begin to interest investors. "Under normal circumstances you'd say these prices aren't too bad here, but we do have all this scary stuff going on in the background," Mr. Caldwell says.
Mr. Caldwell points out that major banks, such as CIBC and Bank of Montreal, are paying dividend yields around 5 per cent, far better than the near-zero rates on bank deposits. Even better, the payouts look secure. "Cutting a dividend in a Canadian bank is a career interruptor," he says. In the U.S., Mr. Caldwell favours defensive stocks, such as drug store chain behemoth Walgreen, railway operator CSX Corp. and software giant Microsoft. He says investors should selectively buy stocks with decent dividends and strong balance sheets "in case things do get whippy."
Tony Boeckh, a Montreal money manager and publisher of the Boeckh Investment Letter, recommends investors stay cautious. He has less stock exposure in his portfolio than normal, but would become fully invested if there were a decent sell off, because many stocks in Canada are trading at inexpensive valuations. He doesn't foresee another gut-wrenching decline, such as a drop back to the 2008-09 lows. "I think a lot of the bearishness is built into the market. I mean, you can't pick the paper up without reading article after article about how the world's going to blow up," he says.
The S&P TSX composite index will likely rally back to around the 12,000 mark by year end, according to Paul Taylor, chief investment officer at BMO Harris Private Banking. He says it's "a realistic target," provided Europe avoids a worst-case scenario in which the euro zone breaks up. Mr. Taylor believes stocks represent compelling value, at least compared to bonds. Among big firms in Canada and the U.S., the average earnings yield (basically a firm's per-share profit divided by its share price) is about 7.5 per cent, compared to less than 2 per cent for 10-year government bonds. "Certainly, on a relative basis, versus … bonds, [stocks are] particularly cheap," he says.