• The Equity markets seem to have got some mojo back in the first month of the year. At this writing the MSCI All Country index is up 4.0% year to date. The rally that began in early October has been accompanied by a decline of volatility and marked improvement in sentiment indicators.

  • The reasons for the current strength of the market include easing of monetary policies, better-than-expected indicators in the U.S. and little propagation of the European recession to the rest of the world.

  • The U.S. central bank continues to keep monetary policy easy. Its policy rate of 0.25% is the lowest since the Fed began targeting interest rates. At their latest FOMC meeting policy makers said that the policy rate would remain unchanged at least through 2014, extending the previous pledge by 18 months. However, unlike late 2010 when QE2 drove bond yields and equity prices higher we expect a more muted reaction from investors resulting from recent FED rhetoric.

  • The U.S. and Canadian earnings outlook for 2012 is increasingly conservative. The primary culprit is profit margins, which are likely to grow marginally if at all over the year. In both countries this fundamental has begun the year at historical highs.

  • We expect an ebb and flow of equity prices in 2012, the major drivers being monetary easing in emerging markets – promoting a reflation trade – versus debt problems in the developed world and the uncertainty surrounding them. We see current Canadian and U.S. equity prices as close to fair value. Upside remains, but the pace of gains will slow.

  • We maintain our preference for defensive sectors with large dividend yields, particularly Telecoms and Utilities. However, we are making some tactical changes this month. We recommend an increase in the capital-goods industry group to overweight. We are also increasing our exposure to automobiles & components from underweight to overweight, as this Canadian industry will benefit from U.S. economic developments. We suggest profit-taking in real estate stocks, which have done extremely well since our September recommendation to overweight.