Equity Clock

An Outlook for North American Equity Markets in 2011

Prospects for North American equity markets are better than average in 2011. However, there will be surprises along the way. North American equity markets are expected to continue to follow the four- year Presidential Cycle and investors can benefit by adding equity exposure during the first half of the New Year.

Historically, the best time to own North American equity markets during the Presidential Cycle has been from October prior to the U.S. mid-term election to its high in October in a pre-election year. Since 1950, the 12-month rally from the mid-term election year low to the pre-election year high averaged a gain of 24 percent for the S&P 500 Index, 19 percent for the Dow Jones Industrial Average and 23 percent for the S&P/TSX Composite Index. Positive returns were recorded by the S&P 500 Index in 15 of the last 15 periods. Returns ranged from a low of 5.87 percent in 1978/1979 to a high of 40.12 percent in 1986/1987, with 11 of 15 periods showing gains topping 20 percent. Since the beginning of October, the Dow Jones Industrial Average already has gained 7.9 percent, the S&P/TSX Composite Index has added 9.4% and the S&P 500 Index has advanced 11.1 percent.

The reason why the Presidential Cycle works is because of the U.S. political process and its impact on North American economies. Historically, a U.S. president will use much of his political capital on contentious issues during his post-election and mid-term election years. Frequently, contentious issues increase economic and political uncertainty prior to the mid-term election. After the mid-term election, uncertainties are reduced. In addition, the President tends to become more compliant to issues that either will help him to become re-elected or will set the stage for someone in his party to become elected. Sound familiar?

Unfortunately, there is a catch in 2011 that will cause North American equity markets to vary briefly from their historic pattern. North American equity markets already are short term overbought after the bull market rally since the beginning of September. Key indices are vulnerable to a brief correction in the first quarter. The correction, if any, will provide an opportunity to add to equity positions in order to take advantage of the remaining Presidential Cycle “sweet spot”. Preferred equities are economically sensitive sectors including materials, industrials, energy and consumer discretionary.

What are some of the issues that are likely to influence North American equity markets in 2011? The $600 billion quantitative easing program in the U.S. and the economic stimulus program passed by Congress near the end of 2010 will have a favourable impact on corporate earnings, economic growth and employment during the first half of 2011. Equity markets are poised to benefit. Unfortunately, increasing government deficits eventually will have a negative impact on the U.S. Dollar. Other developed nations already have taken steps toward fiscal and monetary responsibility. Eventually, the Federal Reserve and the U.S. government will be forced to move if the U.S. Dollar is to remain the international currency of world commerce. When the Federal Reserve and U.S. government take away the economic stimulus punch bowl, North American equity markets are vulnerable to a significant correction.

Despite near-term vulnerabilities, gains by North American equity markets in 2011 are set to reach approximately 15 percent from current levels. This implies an upside target on the S&P 500 Index to 1,450 and 15,500 on the TSX Composite Index.

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