The attack of September 11 shook the investment environment to its foundations as the basic concept of risk was quickly reappraised. Stocks, especially those whose revenue is susceptible to changes consumer confidence, fell dramatically with the MSCI World Index plunging 11 %. High quality short term bonds and gold were the only refuge in a world that has suddenly become transfixed by developments in Afghanistan, a country that does not have a functioning economy, let along financial markets.

Indeed, the integrated nature of the global economy and its capital markets were illustrated not only by coordinated central bank intervention but also by the similar environment. As earnings predictability has become scarce, predictable earnings have become more valuable. Progress in the new war on terrorism will largely determine the mood of the consumer who is now being helped by aggressive central bank interest rates cuts and more fiscal initiatives. At the moment, the stock market is being held hostage by rising equity risk premium.

The bond markets may suffer from a slight increase in yields over the next year as the aggressive easing of U.S. and Canadian central banks sparks an economic recovery, but also heightens concerns about future inflation. Look for Canadian corporate bonds to outshine their government counterparts as business conditions improve and credit spreads decline.

Canada

While expectations for technology stocks continue to be weak, the sector is believed to be close to the bottom and if so, will likely remain range bound until an economic recovery is confirmed. The resource sector is expected to remain relatively strong as seasonal demand increases, while industrial and manufacturing stocks also await the cyclical recovery. In the meantime, conservative stocks such as financials and utilities look to offer the most stability. After a period of weakness, the Canadian dollar is expected to outperform in the short term.

U.S. Market

The S&P 500 posted its biggest quarterly drop since the crash of 1987, tumbling 11 %. Stengths and weaknesses were similar to the Canadian equity market as technology and consumer discretionary stocks sank while food, beverage and tobacco stocks rose. Healthcare companies strongly outperform with Johnson and Johnson rising 11%. Travel related companies, however, were hampered as airlines, cruise companies and theme parks will suffer from reduced demand. Merger activity still occurred of which the most noteworthy was the proposed combination of Hewlett Packard (-44%) and Compaq (-46%). The combination was not well received by the market unlike the forest products merger of Mead (+2%) and Westvaco (+6%)

The impact of the U.S. Fed rate cuts, with its normal lag period of six to nine months, will not be felt until the fourth quarter of this year, if not early 2002. The earnings outlook, albeit weak following a steady flood of disappointing news, should improve by the start of next year. Meanwhile, continuing uncertainty over the extent and duration of the slowdown will likely translate into added volatility in U.S. stocks.

Europe

The outlook for euro zone equities continues to be clouded by the lack of earnings visibility resulting from the ongoing weakness in global demand. The situation is exacerbated by the European Central Bank's inability to lower interest rates, as the central bank remains focused on price stability at the expense of growth. In this environment investors will likely remain defensive until signs of an economic recovery surface.

Japan

With the Japanese economy mired in another recession the short-term outlook appears somewhat uncertain. A mild economic slowdown is already priced into the markets, but a prolonged recession, possibly made worse by the implementation of structural reforms, may cause further declines in the short term. However, these reforms could be the catalyst needed to push the markets higher, and help the economy thrive in the long run.

Emerging Markets

Uncertainty in the emerging markets remains high, as the developed markets grapple with global weakness. The sharp fall in global demand has precipitated a retreat in economic growth forecasts in Asia for the balance of the year, while the Latin American and emerging European markets are likely to be hampered in the short term by the ongoing difficulties in countries such as Argentina and Turkey. However, emerging market equities, given their attractive valuations, are poised to stage a rebound when sentiment improves.

What is an Investor to do?

Unfortunately with investing, they don't ring a bell to let you know when the market reaches its bottom. So how can you pick the best time to invest? The most effective solution is the time-tested principle of “dollar cost averaging.” This process lets you enter the market carefully, without the risk associated with a single lump sum investment. It works as a series of systematic, small investments, which actually smoothes the effects of market volatility. The dollar cost average concept is simple. Rather than making a lump sum investment (and risk timing the market badly), you invest a set amount at regular intervals, in an investment of your choice. Each time the market moves temporarily lower, your investment buys more units at lower prices. When markets come back, you buy fewer units at higher prices. Over time, this can result in a lower average price and a higher capital gain.There are several funds out there that practise the dollar cost averaging concept within their portfolios.

If your leaning towards the idea that the US market is near its bottom, then dollar cost averaging into a focus American Growth fund could lead to high returns down the road.

This commentary was compiled by John Klotz., B.A., CFP.,CH.F.C. John is a Certified Financial Planner with LMS Prolink. He has over 10 years of insurance and investment experience and develops personalized plans for his diversified client base. You can reach John at (416)-595-7484 ext. 305 or email at johnk@lms.ca