Equity Strategy October 5, 2007:

The North American equity markets continue to surge forward, it appears that investors have shrugged off the credit crunch as a one off temporary problem. The Federal Reserve has ignited investor optimism by lowering interest rates and appearing to indicate that they have fewer inflation concerns going forward.

The anticipation of lower interest rates in the US has added fuel to the investor buying spree and there appears to be the belief that the US economy can whether any storm as long as the central banks of the world just continue to flood the globe in liquidity. The central bankers have generally followed the wishes of the market and continue to add liquidity in an effort to ensure there will be as little disruption to markets as possible.

The current rally to new all time highs on S&P and year highs on the NASDAQ does not make any sense to me. The equity markets are saying that the US economy will just continue to expand as if nothing of consequence has happened. The decline in the housing sector has only just started and already credit card debt is expanding at a nearly unprecedented pace.  The US consumer is still consuming but the method of financing has changed materially from using the equity in real estate where borrowing rates are low to using credit cards where rates are materially higher. How long can that go on?

It is no wonder that the Canadian dollar has been so strong, the financial picture in Canada is dramatically more attractive than in the US. Canada is not nearly as dependent on the US for trade and has expanded the number of trading partners in Asia over the past few years which should help the economy weather any US slow down.

Canadian investors should continue to avoid US investments as the currency risk remains very high over the short term. Avoid specialty financial companies such as mortgage lenders and maintain a lower than normal exposure to the financial sector, there are still surprises out there.

The oil & gas sector is likely to be a little more volatile than normal due to the current posturing taking place between the Government of Alberta and energy companies over the potential of higher royalties going forward. It does look like the Alberta Government is willing to take a fair amount of short term pain for a substantial amount of long term gain. The industry threat of reducing expenditures in the Province if they decide to raise royalty rates will only slow the economic expansion down over the short term and that might reduce enough pressure for the economy to stabilize and grow over the long term.

Investors should continue to take a very cautious approach to equity investing in Canada over the next few months there is still a number of potential problems that the credit crunch has created that are not fully anticipated at this time.