What’s up with the stock markets?

Good-bye September. Good riddance. It was a lousy month for markets across the board.

The TSE 300 gave back 8.9% during the month, closing at 10,377.9. That was down more than 1,000 points from the record high at the start of the month. But let’s keep things in perspective. We’re still up almost 50 per cent year-over-year, hardly shabby by anyone’s standards. Compare that to a 3 per cent gain on the Dow, a 12 per cent advance on the S&P 500 and a 33.7 per cent increase on NASDAQ and we’re still looking very good.

That’s the bright side of the picture. Unfortunately, there’s a dark side. Enter Darth Vader.

North American stock markets are nervous for a variety of reasons. Individually, most are relatively minor issues. Put together, they spell potential trouble ahead. They include:
· The October effect: Historically, October is the worst month for stock markets. Last year was an exception. In fact, October began the pre-Y2K rally that carried the U.S. markets to record highs before they hit a wall in the spring. But that was an aberration. More often than not, October brings trouble. This is October.

· Technology profit warnings: First Intel.ow Apple Computers. Who’s going to shock the markets next? Investors are starting to run scared as a result of these profit warnings. The fear is that they are symptomatic of a problem that cuts across the entire high-tech sector. Sure, individual companies can run into difficulties. But when the giants start reporting revenue and profit pressures, folks get worried that there’s more to come.

· The Euro crisis: The European common currency is in freefall. The Danes added to the pressure by soundly rejecting a proposal to join the European Community and tie their fate to the future of the Euro. So what, you may ask? So a lot, if you’re a big multi-national company that has traditional markets in Europe. Just think for a moment about Jean Chretien’s rationale for perpetuating a low Canadian dollar. It makes our exporters more competitive in international markets. Bingo! The low Euro does the same thing for European exporters. It also increases the prices of American goods and services in Europe, making them less attractive in that affluent marketplace. Some of the profit warnings that we are hearing with increasing frequency specifically mention this point (e.g. Intel). Reduced sales for major U.S. multinationals is bad, bad news for their stock prices.

· A potential energy crisis: The price of oil dropped after the U.S. announced it would dip into its strategic reserve to the extent of 30 million barrels. Very nice. Problem is, that won’t go very far. And natural gas prices are going through the roof. Have you received the notice from your gas company yet? In the Toronto area, Enbridge estimates the hikes will add more than $200 to the cost of heating an average home this winter. Message: buy shares in firms that manufacture insulation.

The fact is that we will have to be very lucky to avoid an energy crunch in the coming months. Inventories are tight. We need co-operation from the weather and some very good supply management. If things go wrong and oil starts to head back towards US$40 a barrel, it will be great for energy stocks but bad for almost everything else.

· Escalating inflation: The U.S. discovered recently that they had underestimated the rate of inflation in that country. Not by a lot mind you, just a tenth of a percent. It served as a reminder that U.S. inflation is now running at an annual rate that’s creeping towards 4 per cent. That’s enough to get the antennae of the Federal Reserve Board twitching again and renew speculation about more interest rate hikes.

· The U.S. presidential election: On the whole, investors probably don’t care a great deal about who wins in November. As usual, the Republicans are trying to paint the Democratic candidate as a big spender who will run the country into the ground. The weakness in this attack is that Al Gore is an important member of the Clinton administration, under whose watch the U.S. moved from huge deficits to gigantic surpluses. This will hardly stick in voters’ minds as big spending run amok.

More important is what happens after the election. Historically, the year of a presidential inauguration is not a good one for stock markets. If the pattern holds, 2001 will be a washout. Of course, history doesn’t always repeat itself. But with all those other straws in the wind, it will be a brave investor who ignores the past this time around.

· Bottom line: We’ve had it so good for so long that we’re reluctant to admit the party may be winding down – indeed, that the process may have already started. And perhaps we’ll muddle through yet again, and the markets will come roaring back. We’ve seen it before. But the wise investor will ponder all this, review his or her portfolio, and make adjustments where appropriate. It’s time to adopt a more defensive mode, at least for the next few months.

That does not mean sell everything – indeed, there are situations in which you should be strategically buying. It does mean taking some profits, shifting some assets into lower-risk securities, and positioning yourself for what could be some uncomfortable months ahead.

The Internet Wealth Builder is a weekly e-mail newsletter edited and published by Gordon Pape. Subscription information is available at: http://gordonpape.fifty-plus.net