Talk turns to market recovery time

The Ottawa Citizen
November 27, 2008


By Keith Woolhouse, The Ottawa Citizen

From Pacific Rim leaders to stock market analysts, from economists to Stephen Harper, everyone is getting into the act of predicting when they think the recession will end, even though in some parts of the world, Canada included, the recession has yet to even come officially leave the starting gate.

Pacific Rim leaders at the APEC (Asia Pacific Economic Cooperation) summit declared that the economic crisis would be history within 18 months. “Within” is open to interpretation and 18 months mired in the current economic plight is too painful to contemplate.

Our prime minister opted to disagree with his APEC colleagues, and with a master’s degree in economics, so he should. “I think it would be premature to speculate on that kind of timeline,” he said. Hopefully, Our Man At The Top considers a shorter duration more likely.

Forecasting where the economy and stock markets are headed is, at best, a tricky process. There are so many intangibles and it requires accepting past certainties and applying them to the future, while hoping that no uncertainties lie in wait. Guess what. There are always uncertainties. But that doesn’t stop analysts from treading the same well-worn path forward and neither should it for, as Warren Buffett observed: “In the business world, the rearview mirror is always clearer than the windshield.”

Although no two recessions are exactly alike there are lessons to be learned from the past.

On average, upon the outset of a recession it requires 41 months for the S&P/TSX composite index to return to its previous high. Canada, bolstered by the commodity sector, was late announcing its arrival to the Crash of 2008. The U.S., England, Japan, Germany and much of the rest of the European Union are in far more serious straits than Canada, due to their deeper exposure to sinking housing prices, months of job losses and turmoil in the financial markets.

But if the 41-months rule prevails, it may not be until late 2010 or early 2011 that the S&P/TSX returns to its 15,073-point high of June 18. That’s a scary thought, but in keeping with those of
Benj Gallander of Contra the Heard.

“When the market will hit the bottom is not necessarily the most critical question,” he says. “I think the more important one is: After a bottom is reached, how long until we see a meaningful upside? I’d peg ‘meaningful’ at 25 per cent. Minimum. Then, if that is achieved, will markets maintain the upper levels, rather than just getting there and then dropping?

“While a bottom could be pretty imminent, or down another 20 per cent or so, it would not surprise me if it takes years, say until 2011, before we are out of this mess. However, given how difficult it is to predict, it will likely prove worthwhile to peck away now at battered positions that pay a dividend. Or companies that have excellent balance sheets, while leaving cash on the sidelines to deploy later when the risk is reduced even if the reward side is somewhat diminished.”

Robert Kavcic, economic analyst at BMO Nesbitt Burns, acknowledges that the magnitude of the markets’ decline is discouraging — all three major North American indexes continue to stumble and have fallen around 45 per cent off their highs — but he sees cause for optimism in the S&P 500’s recovery from a six-year low.

The concern is that this could be a fleeting upturn and the markets may well get sideswiped again. But at current levels, stocks offer an attractive risk/reward entry point for patient, long-term investors, says Dundee Capital Markets portfolio strategist Martin Roberge.

For the first time since 1958, the S&P/TSX composite’s yield is higher than the 10-year Government of Canada bond: 4.8 per cent versus 3.4 per cent. Based on 10-year trend earnings, the index’s price-to-earnings ratio is just a tad above 15, the cheapest since 1990, while the S&P 500’s is 14, the cheapest since 1982. That points to long-run rates of return of around seven per cent for stocks, or about 10 per cent with dividends included.

The only concern is that if equities do suffer another setback it would drive dividends higher and leave them exposed to reduction. Indeed, the S&P 500 and the S&P/TSX are trading sharply below their 50-day and 200-day moving averages and in a distinct falling trend, suggesting markets could worsen before they get better, says Ron Meisels of Montreal-based Phases & Cycles.

Three previous prolonged periods of contraction — the Great Depression, the 1970s and the early 1990s — lasted about 15 years and drove multiples down to 10 times earnings before another expansion took hold. Conceivably, P/E ratios, which peaked in 2000, could contract for another seven years, says Kavcic. “Does that mean stocks will fall until 2015? No. In all past episodes of valuation contraction, stocks enjoyed multiple cyclical bull markets with gains of over 30 per cent, including the one that ended last year. As of now though, with economies around the world deteriorating and earnings still missing estimates, it looks like the next bull is still in hiding.”