October 24, 2013

Bulls, Bears and Pigs on Bank of Canada Pessimism

From Bulls, Bears and Pigs

The bank of Canada today (Oct 23) cut its Economic outlook. Here's the just of it

“Uncertain global and domestic economic conditions are delaying the pick-up in exports and business investment, leaving the level of economic activity lower than the bank had been expecting". 

They downgraded their outlook for Canadian and US growth next year. They  said the threat of deflation is now greater than inflation and Canada would not be operating at full production untill the end of 2015 which is another way of saying they don't seen any inflationary pressures building.  As a result they dropped the "were gonna raise interest rates soon" threat they had been making for over a year, which I and probably a lot of others knew was bogus as they are pretty much handcuffed until the US moves first. 

This BOC statement says a lot. It's LT bullish for the market for it shows that we are nowhere close to seeing the classic signs of peak.  Towards the end of an economic expansion and thus bull market, the outlook from central banks and people in general is rosy, not sour like this.  More importantly, near the peak we start to see signs of "overheating" which results in rising inflation to the point where it becomes a concern for central banks and they respond by tightening interest rates. When they tighten to the point where the yield curve gets inverted it sows the seeds for the next recession. We are nowhere close to overheating as there remains a large output gap as BOC noted and money is far from being tight - it's at the opposite extreme. 

Now, just because monetary and economic conditions are still bull market friendly  does not mean the market can't have serious corrections. We saw such in 2010 and 2011. What it does mean is that you should continue to be a LT optimist and continue to look for long opportunities while ignoring the doom and gloomers. Of course, you should be mindful of corrections and not get greedy after the market has had such a large run. After all, big corrections do hurt and there's no guarantee that the bull market can't end until monetary conditions are tight. Trim into strength, raise cash, hedge if you must but don't put yourself in a position where you are net short. Always remember though that trends will always surprise people in their strength and duration and so very, very few people fully capitalize as they tend to get out too early. Even those broken clock bears who were right in being negative in 2008 did not come close to fully profiting from the collapse as most covered shorts around 1100 (according to my anecdotes).