Market Update

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August / 04 / 2008
Economic Outlook
Defining the next six to 12 Months
By Benjamin Tal
With the S&P 500 Composite Index officially in bear territory and the VIX Volatility Index reaching new highs, a year from now, we will refer to the current period as the "bad times". But between now and then, what will define the next six to 12 months? The following is a brief discussion of the main themes that we think will dominate markets in the near term.
Currently, we are probably at the bottom of the cycle. In the U.S., the economy is probably shrinking and in Canada, we are starting to see consistent signs that the labour market is slowing. We will likely stay at this bottom for a few more months with early signs of a sustained recovery appearing in the fourth quarter of 2008.
Inflation
The trend is up. The main reason for higher inflation down the road is surging energy and food prices. Until recently the Federal Reserve Board (the Fed) and the Bank of Canada (BoC) were focusing only on core inflation (which excludes food and energy prices). However, realizing that the current rise in food and energy prices is more structural in nature, both central banks are focusing more and more on "all-items" inflation that includes the food and energy components.
Interest Rates
With inflation rising and the economy slowing, we are in a period of stagflation. The Fed and the BoC are in a difficult position since raising rates now to fight inflation will further damage an already fragile economy. So what to do? The best guess is that both central banks will wait until the end of the year before starting to raise rates.
The Stock Market
Given the current anxiety in the market, it is important to put the current sell–offs in historical perspective. Since 1970 the U.S. has lived through seven instances in which the S&P 500 has fallen by more than 20 percent. The first one was in 1973-74 and the most recent one was following the tech bubble in 2000-02. The average duration of those instances was 13 months and the average decline in stock prices from peak to trough was 30 percent. The current bear market is almost 10 months’ old and the cumulative decline in stock prices is just over 20 percent. This, along with the still weak economic fundamentals, suggests that it probably will take the U.S. market a few more months before it turns a corner.
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For Advisor Use Only. This material was prepared for investment professionals only and is not for public distribution. It is for informational purposes only and is not intended to convey investment, legal or tax advice. This material and/or its contents may not be reproduced or distributed without the express written consent of Renaissance Investments. Renaissance Investments is offered by CIBC Asset Management Inc. TM Renaissance Investments and "invest well.live better." are trademarks of CIBC Asset Management Inc.
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