Market Outlook August 1, 2011

What a week! The TSX dropped about 500 points (4.1%) over the course of the last week. Judging from the phone calls my office has been receiving, the worry is over the prospect of a US default. My thoughts on that further down. For a portfolio balanced between stocks and bonds, bonds are certainly the place to be for safety. However, avoid US t-bills, because that is where the negative effect will be felt if there is a partial default.

Gold did well last week, especially on Friday. The price was up 2.0% for the week, which is 6.1% better than stocks. And due to the increased momentum, an investor who is using an asset rotation strategy should own gold (IGT) again this coming week. And given the poor political outlook for the USA, that seems like a very wise idea.

Yields have fallen on Canadian government bonds. That makes sense, because investors have been seeking a safe haven. The American government looks like it won’t be able to increase its debt ceiling. What this means is that they won’t be able to sell as many bonds as the bonds that are maturing. They won’t default on all their outstanding bonds, only on a small (?) portion of the bonds that are maturing in the near future. I seriously doubt there will be extensive or large investment losses. What is far more likely is the loss of confidence of investors in the US government. The dollar is likely to fall as people sell American government bonds and reinvest their capital in their own country. However, I recall that the American government has been criticizing the Chinese government for not allowing their currency to rise faster against the US dollar. There are two sides to that comparison, and this may turn out to effectively devalue the US dollar (versus the Chinese renminbi, as well as other currencies) and make the US exporters more competitive. The Chinese, who own billions of US bonds and who export to the US are not likely to be pleased.