Bust to boom? Not so fast!

Bust to boom? Not so fast!
Monday, October 20, 2008

Gordon Pape


TORONTO (GlobeinvestorGOLD) --There was certainly nothing in the news to send stock prices higher last week. But investors, who just a few days earlier had been selling at the slightest excuse, suddenly decided to ignore the drumbeat of dismal reports and went on a buying spree.

As a result, the TSX/S&P composite index recorded its first weekly gain since the middle of September and it was a pretty impressive one – almost 500 points (5.5 per cent). Anything on the upside is a welcome change these days but this was better than we might have expected thanks to Friday's surge.

There was no obvious reason for Friday's 292-point jump, other than a modest recovery in the price of oil.

If anything, we might have expected another sharp sell-off after the latest consumer confidence numbers showed that both Americans and Canadians are scared to death about what's going on and what it all means for the economy and to their lives.

The Conference Board of Canada said on Friday that its confidence index has dropped to the lowest level in 26 years. That would take us back to 1982, a time when the economy was in recession while interest rates were near record highs.
Things are even worse in the United States, where the University of Michigan reported its consumer sentiment index recorded its biggest monthly drop in history, falling to 57.5 per cent from 70.3 per cent in September.
If that wasn't enough to discourage investors, we learned that the U.S. housing slump isn't going to end any time soon with a report from the Commerce Department that showed a 6.3-per-cent decline in new home construction in September.

Home building is now at its lowest level since the recession of 1991.
Okay, that's all bad but your pension is safe, right? Not so fast! Another report on Friday revealed that the value of major Canadian pension plans fell 8.6 per cent in the third quarter.

That brought the total decline for the year to more than 10 per cent. And pension fund managers are supposed to be the most cautious and conservative money experts around. If they're getting hammered, it's no wonder people are worried about their registered retirement savings plans.

About the only motivator for investors was Warren Buffett's article in The New York Times in which he wrote that the time has come to buy stocks. In a column titled "Buy America. I Am." the Oracle of Omaha said that selling shares in sound, well-run companies makes no sense.

"These businesses will indeed suffer earnings hiccups, as they always have," he wrote. "But most major companies will be setting new profit records five, 10 and 20 years from now." For his part, he has been selling bonds and buying stocks.

Ironically, U.S. investors seemed to ignore Mr. Buffett as the Dow dropped 127 points on the day, although it produced an overall gain for the week. But Canadians went to their phones and starting placing buy orders. Suddenly, we went from bust to boom. Or did we?

Actually, we've seen this story before – just a few days ago, in fact. On Tuesday, the TSX leaped more than 900 points as Canadians caught up with the global rally they had missed while they were enjoying their Thanksgiving holiday. Then on Wednesday, buyer's regret set in to the tune of a 631- point drop. So before we get too excited, let's see what Monday brings.

While it's nice to go into the weekend on a high note, I'm not convinced we've seen the market bottom yet. There are early signs that the international banking bailout is having an impact and that the credit freeze is easing. That's good news but we are still faced with the reality that we're about to move into a recession, if in fact we aren't already there.

The next several months will bring a litany of gloomy economic numbers and weak earnings reports. Investors will react accordingly and there will be more days of triple-digit declines.
So we're not out of the woods yet, not by a long shot. As I've said in the past, market rallies offer an opportunity to review your portfolio and, if appropriate, to reduce risk by selling some equity positions. If you need to sell, do it at a time when prices are moving higher, not in a market plunge.
If you decide you want to buy at these levels, pay attention to Mr. Buffett's sage words. Focus on industry leaders that generate strong cash flow and have good balance sheets. Those are the stocks that will pay off big-time in a year or two.
Gordon Pape is one of Canada's best respected financial authors and the nation's leading expert on mutual funds.

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