Moves in Energy and Dry Goods for 2010 Canadian Stock Market

Moves in Energy and Dry Goods for 2010 Canadian Stock Market

Valuations High, No Rush to Jump In

The last half of 2010 saw a welcome rebound in world markets, as investors began to look beyond the long-awaited economic recovery. But just as the markets were getting their footing, concerns over the debt crisis in Europe unnerved investors and the major indexes waited until early December to finally push above their prior 2010 highs set at the start of the second quarter. In 2010, the strong performance of materials propelled the TSX to two-year highs, with a calendar-year return of 17.6% including dividends.

The energy sector helped out, with its final upward surge in December (on the back of rising Oil Gas Stocks) after languishing for almost the entire year. For the year, the S&P 500 rose 9.1%, the S&P Europe-Pacific-Asia Composite Index gained 4.9% and the S&P Global Index returned 9.1% (all returns in Canadian dollars). After languishing almost all year, the TSX Energy Index finally began to move in the last quarter of 2010. We believe that high oil prices are here to stay, as economic reserves are getting harder to find, and emerging market demand continues to rise. The TSX Energy Index is about 80% weighted to Oil Production.

2010's volatility has reaffirmed a commitment to keeping some cash on hand in case buying opportunities arise. At the moment, the S&P 500 is not trading at a particularly compelling valuation (about 18 times forward earnings, when it usually trades in the 14-16 times range), so firms will be comfortable with relatively high cash weighting at the moment.

Distress Signal from the Baltic Dry Index

The Baltic Dry Index measures the cost of shipping dry raw materials, which are used in all manufacturing processes. A rising BDI means that manufacturers are placing orders for their own businesses, presumably due to more orders from their customers. From 2009 until its 2010 peak in late May, the BDI was in a solid uptrend. Then in June it pulled back sharply, recovered in late summer, only to retreat again in the fall and has been in a downtrend ever since. It is on the verge (green circle) of testing the support level established in mid-July and a breakdown below this level would be quite negative. We will continue to watch this closely as it will influence our perception of risk to the world economy.

But Dr. Copper says everything's ok. Often referred to as "Dr. Copper" due to the metal's "Ph.D. in the world economy", we can clearly see that the price of copper is in a strong uptrend. Since copper is used in all aspects of industrial activity, its price provides a gauge of how the world economy is doing. The price continues to power ahead. A severe pullback breaking this uptrend would be serious cause for concern, but for now we are content to maintain our exposure to base metals and materials.

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