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RPT-BAY STREET-Jittery Investors Could Pull Back in October

Monday, 04 Oct 2010 07:27 AM

 

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(Repeats Sunday's column)

* Fair chance seen of October pullback, not crash

* Risks include data, earnings, Europe, U.S. politics

* Medium term outlook for TSX still strong

By Claire Sibonney

TORONTO, (Reuters) - Canadian investors defied September's track record as the worst month for stocks, but they may be too scared to lift Toronto stocks much further in the historically treacherous month of October.

The TSX rallied to a two-year high last month, wrapping up its best quarter of the year so far. But strategists and fund managers say a drop of a few percentage points is now a strong possibility.

"If markets are overbought, if we've had a fabulous run, particularly in the U.S. in September, then all of that does suggest a pullback in October," said Patricia Croft, retiring chief economist at RBC Global Asset Management.

Spooky stories about October don't help matters, she said.

October typically ekes out modest gains for equities, but it's also a volatile month, and has been marked by the biggest crashes, including the catastrophic meltdowns of Black Tuesday 1929 and Black Monday 1987.

Most recently, the TSX plunged 17 percent in October 2008 when the global financial crisis was at its peak.

Closing at 12,363.08 Friday, the Toronto Stock Exchange's S&P/TSX composite index is now well above the median year-end forecast of 12,225 in a recent Reuters stock poll.

But markets face a number of near-term risks. These include more deterioration of economic data out of the United States and the chance that third-quarter U.S. and Canadian earnings reported later this month could disappoint.

"The psyche of investors is still fragile," said Garey Aitken, Calgary-based chief investment officer at Bissett Investment Management, a unit of Franklin Resources Inc.

"I don't think there's a lot of conviction on the part of investors that we're setting the stage for big sustained upswing."

Also weighing this month is uncertainty over extending George W. Bush-era tax cuts as U.S. midterm elections loom as well as the likelihood of more bad economic news out of Europe.

Stephen Wood, chief market strategist at Russell Investments in New York, noted that while the U.S. Federal Reserve is prepared to embark on a second round of quantitative easing, Europe is still withholding stimulus.

"Where Bernanke is kind of like 'paddles, adrenaline needle to the heart,' Europeans are still talking austerity, sterilization of central bank intervention," he said.

Wood added that further debt downgrades in the euro zone -- of which Spain is the latest casualty -- will be less surprising, but could still rattle the market.

There is some weakness from a technical perspective as well. Ron Meisels, technical analyst and president of Phases and Cycles in Montreal, said mid-October presents the next major window for this. The maturing of the 21-day, 70-day and the 39-week cycles could all culminate into a mild pullback, which he said should be taken as a signal to buy.

"There is a lot of money on the side...people will start waking up," he said.

STOCKS MISTRUSTED, UNLOVED

While analysts and investors are talking about a pullback, few foresee a full-blown correction of 10 percent or more.

"For the market to take a pretty significant downturn, we're going to have to see the economic data turn south as well as earnings," said Youssef Zohny, associate portfolio manager at Van Arbor Asset Management in Vancouver.

Many strategists are also encouraged by a key contrarian indicator -- retail investors have been shunning stocks in favor of low-yielding fixed income.

"Last time we saw such lopsided flows ... was when everyone rushed into stock funds in '99 and 2000," said Kate Warne, Canadian market strategist at Edward Jones in St. Louis.

March 2000 marked the climax of the dot-com bubble, followed by relatively low returns for equities for a decade.

"The next 10 years it's much more likely you're going to see stocks outperform bonds, particularly if we begin to see rising interest rates," she said.

Converging spreads between the dividends paid on stocks and government debt yields are also seen as supportive. In recent decades bond yields have been higher than dividends because stocks were seen having greater potential for price appreciation. But in many cases, this relationship has flipped.

Royal Bank of Canada, the country's largest lender, has a dividend yield of about 3.73 percent. A 10-year Canadian government bond yields just 2.8 percent.

"People obviously have been scarred by what we've lived through in the past decade but particularly the last couple years," RBC's Croft said.

"Stocks are just so mistrusted, so unloved, that I think there is an opportunity here." (Editing by Jeffrey Hodgson and Janet Guttsman)

© 2014 Thomson/Reuters. All rights reserved.

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