July - Summer Edition - CI Investments

Commentary
However, if investors were truly concerned with financial
collapse in Europe, the euro would not be holding up as
well as it has. The euro could yet collapse or it may rally
to new highs – making a prediction is not the objective of
this analysis. The point is that, rightly or wrongly, the euro
exchange has yet to flash a crisis signal.
In a similar vein, European sovereign debt concerns have
not yet triggered a material decline in the U.S. Financial
Conditions Index as they did one year ago (Chart 2). This is a
bit surprising, particularly given recently heightened concerns
of a slowdown in China over inflationary risks. Additionally,
the world’s third-largest economy, Japan, is acting as an
economic drag in the wake of the Fukushima disaster. And
yet, financial conditions remain positive within the U.S.,
whereas one year ago they had turned negative. Note that the
chart illustrates the immense size of the financial earthquake
in the fourth quarter of 2008 and the ensuing aftershocks,
thus providing some perspective. Importantly, the aftershocks
are getting smaller.
Perhaps the forces of healing have taken hold as we move
towards the three-year anniversary of the collapse of Lehman?
Corporate balance sheets of North American companies are
in phenomenal condition, providing the economy with a
basis of financial stability that simply did not exist three years
ago. While economic growth has been sluggish and U.S.
employment lags, S&P 500 earnings per share are estimated
to reach a record level of US$99.27 this year, surpassing the
previous record of US$84.67 set in 2007. Equities are cheap.
During the lows of late June, the S&P 500 was trading at its
second-lowest price-to-earnings ratio (on 2011 estimates)
since 1985. The only time, since 1985, the U.S. market was
cheaper was during the panic sell-off that occurred in the six
months after Lehman’s collapse. Even the much-maligned
U.S. consumer is in better shape. According to Equifax,
average credit scores in June reached their highest level in
over four years. So, while U.S. federal deficits continue to
expand, corporations and consumers are improving their
financial conditions. Eventually, the U.S. government will
need to get in on the act, and we will see what happens with
the debt ceiling negotiations this summer.
Deleveraging is a continuous process and investors should
expect more aftershocks. However, they should not forget that
bull markets are characterized by two steps forward followed
by one step back. Overall, positive fundamentals – continued
liquidity, good valuation support and restrained sentiment –
outweigh the negative macro risks and the market is prepared
for a step forward.
Bloomberg U.S. Financial Conditions Index
2
0
-2
-4
-6
-8
-10
-12
-14
Dec.
2006
Jun.
2007
Dec.
2007
Jun.
2008
Dec.
2008
Source: Bloomberg. As of June 30, 2011.
Jun.
2009
Chart 2: The current Greek crisis and concerns over European sovereign debt
has not triggered a material decline in the U.S. Financial Conditions Index
– as it did a year ago.
Managers: Aaron Clark, Alec MacIsaac
Analysts: Ben Boult, Steve Maksymyk
Dec.
2009
Crisis I
Jun.
2010
Dec.
2010
Crisis II
Jun.
2011
36 SUMMER 2011 PERSPECTIVE AS AT JUNE 30, 2011