The U.S. third quarter earnings season is upon us, and many DOW and S&P companies have already reported their most recent results. The early numbers reveal that approximately 70 per cent of companies that have reported have beaten analyst’s expectations -- some of them by quite a large margin. Is this another encouraging sign that the recession in the U.S. may be coming to an end? Good earnings combined with a weak U.S dollar seem to be driving this market higher.
There seems to be a clear pattern that has developed in the U.S. and Canadian stock markets during this most recent massive rally off the market lows. That is, a weak U.S dollar and the rise of the North American markets, which was followed by many of the world’s stock markets as well. On the other hand, given a strong dollar, the market tends to fall.
One key reason for this phenomenon is that much of the rally has been led by commodities, oil and gold. These products are valued in U.S. currency, so more of them can be purchased if the U.S. dollar is weak, driving their prices higher. While other sectors have participated in this rally -- such as technology companies and banks -- they have followed a similar pattern with regards to the U.S. dollar. This pattern poses a very large dilemma for the U.S. Federal Reserve. If they allow the dollar to continue to fall against other world currencies, it may be great for the stock market, however in my opinion, they risk having the U.S. dollars’ status removed as the world’s dominant currency, and countries may stop buying them all together.
This earning season has been fantastic with many companies such as Microsoft, Apple, Google, and JP Morgan among may that have all reported better than expected earnings. Some of these companies have shown tremendous increases in their share price because of their recent quarterly earnings, while some have not. For investors, this can be quite confusing. The reason for certain stocks not rising even though they may have had good earnings is that the market is quite intelligent and may actually factor in the better than expected earnings ahead of time. Thus, when earnings do get reported, the market sells on the good earnings report -- a phenomenon that provided the phrase “buy on rumour, sell on fact.” However, the market is at yearly highs helped by this great start to the earnings season in the U.S.
The Toronto Stock Exchange seems to follow the recent patterns of the U.S. stock market. One reason is that more than 50 per cent of the TSX is made up of gold, oil and other hard assets or commodities. In my view, a weak dollar is good for our exchange because our base metals, gold and oil companies' shares move higher. However, on the flip side, a high dollar is bad for sectors such as manufacturing, and industries like tourism and film. Exports from Canada in general are more expensive to buy, especially for the U.S., which receives 90 per cent of our exports. Thus like the U.S., a weak dollar seems good for the stock market, but may not be good for both countries' economies in the long run.
As investors, we are always trying to take advantage of fluctuations in the stock market that may be outside the normal range. Right now, the strong Canadian dollar is trading well above its historical range while the U.S. dollar is weak, coupled with the better than expected earnings news coming out of the U.S. There are estimates that $3 trillion is waiting on the sidelines to move into the market when opportunity arises. Thus, my recommendation in this environment would be to invest in U.S. multinationals or companies that pay good dividends while also showing a competitive edge in their sector. With a strong Canadian dollar performing well above the 85 cent average, this part of the market is both outside the norm and can be taken advantage of at this time.
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Allan Small is an Investment Advisor with Dundee Securities Corporation, a DundeeWealth Inc. Company. This is not an official publication of Dundee Securities and the author is not a Dundee Securities analyst. The views expressed are those of the author alone, and are not necessarily those of Dundee Securities or Metro Canada.