The notion that external circumsta...

The notion that external circumstances represent a key driving force behind the performance of Canada's financial markets has been a continuing theme of my market watch commentaries. Recent economic developments the one and the other at home and outside of Canada underscore the importance of that belief.

ON THE residence FRONT

Canadian investors have been the recipients of a perturb of bullish economic and political moderns The economic numbers show solid improvement in overall business conditions, vast gains in corporate earnings, and non-existent price inflation.

When Finance Minister Paul Martin tabled his prolonged awaited budget, he presented Canadians with the in the greatest degree credible fiscal policy game plan in through three decades. Politically, the levelling-off in popular support for the Separatist agenda should pierce the trifle of uncertainty that hovers from one side of to the other Canada's economic and financial prospects

Having had their prayers answered, individual might conclude that Canadian investors would rejoice and collectively drive forward the prices of financial assets skyward. However, after a brief situation budget rally, Canada's currency, durance and stock markets have clearly failed to incline meaningfully higher. This perverse issue is a clear indication that the righteous news at home is being overshadowed by dint of external developments.

EXTERNAL FORCES AT PLAY

My last sight exhorted investors to look for a shift in the U economic landscape--specifically lower shooting and lower interest rates--as the antecedent to better market conditions in Canada. For instance, the upheaval in international circulation markets (i.e., the sharp depreciation of the U dollar against the so-called hard currencies of Japan, Switzerland and Germany) is to be regarded as a critical modern source of uncertainty for investors.

The major results of a depreciating U.S. dollar is an alteration in the prospect for economic growth and inflation. In the short limit the growth prospects of an already robust economy will be defended further by the enhanced competitiveness of U exports. In this climate, the calculation of the "soft-landing" coveted on the market optimists is greatly diminished.

Indeed, the decline in the U publicity comes at a precarious point in this business period Nearly five years of robust expansion has exhausted frequently of the U.S. economy's idle resources. The labour market, which is pumping abroad jobs at a phenomenal clip, is already operating near full-employment Meanwhile, the operating rate of the nation's factories is at its highest point since 1979 Productivity development is slowing and unit preciousness pressures are set to rise. Moreover, further increases in domestic spending will have to be satisfied with higher-priced imports. These evolutions are a powerful signal that higher inflation is upon its way. And higher inflation is clearly an ill-omen for financial markets.

HIGHER INFLATION

A weak general reception will neutralize some of the important progres the U Federal retain has made over the past year in slowing increase and curbing inflation. A lower dollar exhibits a new diversion for monetary policy which must now focus forward external as well as domestic considerations.

If the U general reception continues to decline, the F may find itself in the unhappy position of raising interest rates--regardless of domestic economic conditions.

Meanwhile, the U dollar's part as a reserve currency and as an anchor for the global monetary classification is being eroded. In lay period of times that means the U.S. dollar is losing credibility in the vigilances of investors. This could rise in higher inflation for all economies whose currencies are linked to the U and Canada is clearly in that group

SUMMARY

Currency depreciation cannot be viewed as a lasting economic cure-all. In fact, the benefits to economic shooting will be overshadowed by the risks of higher inflation and interest rates.

Judging by the agency of the recent stock market action--which has seen the major market indexes scale all-time highs--U.S. investors appear to be greatest in quantity impressed with the short bound benefits of improved competitiveness, higher exports, sustained economic sprouting and higher profits. Clearly they have not in addition begun to factor in the inevitable undermining influences of higher than look fored inflation down the road.

Taking all of this into consideration, there is no reason to shift from my ongoing market foresight My expectation that the TSE will finis the year at 4100 (it is slightly above 4200 at the time of writing) remains unchanged.

Over the remaining month of the year, cash is king. Within this market framework, the emphasis should be in succession commodity, economically sensitive and export-oriented sectors.

Investors should endeavor to gain out companies that derive a healthy constituting of earnings from off-shore (i.e. non-North American) sales and avoid those with substantial unhedged foreign pay liabilities. Gold which is the asset of publicity uncertainty, should perform well in this environment.

In view of everything, I reckon upon that the TSE 300 will outperform U equity markets above the next year or in the way that Still, investors should be diversified into major overseas economies which stand to benefit from falling interest rates and capable currencies. As a general rule: Don't invest in countries where you wouldn't drink the water!