Globally markets largely sold off during the month of September. The S&P/TSX Composite Index gave up 14.4%, the S&P 500 lost 8.9%, the FTSE All share index was down 15.2%, the French CAC 40 down 11.6%, and the German DAX was down 10.8%. The Japanese Nikkei lost 11.7% and Hong Kong’s Hang Seng was down 14.9%. Overall, the MSCI World Index was down 12.1%. The CAD/USD exchange rate closed September relatively flat against where it began the month.

Economic Events

US policy makers were on the offensive during the month with both the Federal Reserve and Treasury working feverishly to ensure that the US and by extension the global financial systems remained viable. In his testimony to the Joint Economic Committee Fed Chairman Ben Bernanke was very clear in stating his belief that failure to get the current financial crisis under control would have dire consequences for the economy. Prior worries about inflation have been abandoned and the focus is now squarely on economic activity thus making further interest rate cuts likely.

Treasury Secretary Henry Paulson has readied a $700 Bln Troubled Asset Relief Plan (TARP) designed to recapitalize the financial system thereby freeing up lending to the corporate sector. This is particularly important as Federal Reserve easing needs to make it’s way through the financial intermediaries (banks) and into the hands of the companies for it to have any impact on the real economy. Unprecedented tightness in credit conditions are creating hardship for otherwise health companies which will translate into reduced corporate profitability and a reduction in overall economic growth. The TARP is designed to help financial institutions rid their balance sheets of “bad” assets and to free up capital for them to lend into the real economy. It remains to be seen whether banks will perform their traditional financial intermediary function or simply horde the additional capital to guard against further deterioration of their balance sheets. With housing prices in the US showing no definitive signs of bottoming they may be justified in their worries that their capital concerns are not over.

The market clearly displayed it’s displeasure with the House of Representatives failing to pass the bailout package on September 29th. In fact the S&P 500 was down 8.8% on the day: its worst one day performance since the crash of 1987. Investors want to see proof that governments understand the gravity of the situation and see aggressive measures put in place to limit the impact and duration of any economic downturn before they will again turn positive on equities.

In terms of real economic activity, the Leading Economic Index decreased for a second month in a row in August to its lowest level since October 2004. The Coincident Index also fell with large declines in industrial production and payrolls. The Lagging Index increased slightly making the ratio of the Coincident/Lagging index fall to its lowest level since the end of the 1981-1982 recession. We are looking for the eventual improvement in the leading indicators to provide a “light at the end of the economic tunnel” for investors which should in turn support equity prices. That being said, it is uncertain as to when we will see improvement in these indicators.

Earnings

According to Myles Zyblock of RBC Capital Markets:

“65% of S&P 500 and 57% of TSX constituents are reporting positive y-o-y (year over year) earnings growth. Normal cyclical corrections take this number down to 40-45% in the US and 30-50% in Canada. Meanwhile the sell-side bottom-up analysts have penciled in 23.9% and 19.8% earnings growth for the S&P 500 and TSX, respectively, in 2009.”

Thus, even assuming we are entering into an average slowdown, earnings will continue to slow, companies will see quarterly earnings “misses” and analyst estimates will need to be further reduced. This negative earnings reporting cycle will continue to provide a headwind for stock prices until it runs its course.

October will see the release of Q3 earnings numbers for the majority of companies. Investors will not only be watching the quarterly results but also the Q4 and 2009 forecasts for clues as to the severity of the expected economic slowdown.

Fund Activity

The Funds used the equity market weakness to add to positions in a variety of sectors. Purchases of Canadian banks were made in all Funds. Some industrials and cyclical stocks were also purchased in companies with superior long term prospects that were suffering with the general market weakness. The Global Dividend fund reduced its large cash position somewhat and added exposure to the European, Asian and US markets.

While the purchases made in September have somewhat reduced the cash positions held by the funds each of the funds maintained a double digit cash balance at month end with the hope of finding even better opportunities in the months ahead.

Jeff Young, NexGen Financial