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How will the market react?

“We still think the story in the U.S. is pretty good,” said Michael Herring, an investment strategist with BMO Nesbitt Burns. “At this moment in time we are in the process of a correction,” he said. The U.S. and Canadian stock markets are trading below their fair value following the 8 to 10 per cent decline during the past four weeks, he said.

But there are several reasons to remain optimistic that the cyclical bull market will continue. “Zero interest rates will frustrate people [and make them] take risks,” Mr. Herring said, referring to the low-interest rate U.S. monetary policy. Among the positives are the synchronous global recovery under way, competing assets such as government bonds offering low returns, investor cash balances being high and the strong corporate cash flows that should encourage capital spending and acquisitions.

“As more and more people get involved we will want to take money off the table,” he said.

However, BMO Nesbitt Burns expects the major U.S. and Canadian indexes will fall short of their previous highs. The S&P 500 and the Dow Jones industrial indexes reached their highs of 1,565.15 and 14,164.53, respectively, on October 9, 2007, while the S&P/TSX posted a high of 15,073.12 on June 18, 2008.

Wednesday, the S&P 500 closed at 1,067; the Dow at 9,974; and the S&P/TSX at 11,543. BMO has a target for the S&P 500 of about 1,350.

The right level for stocks?

The correction has left stocks looking neither cheap nor expensive, David Berman says

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Still the stock market is likely to remain volatile. “We’re still pretty cautious,” said David Andrews, director of investment management and research for Richardson GMP Ltd. “Markets from a technical perspective [globally] have broken technical support levels.”

Nevertheless, the economic fundamentals are strong, he said. “We have an economy that no longer needs to be goosed along by fiscal stimulus,” Mr. Andrews said. “I think [it] can stand on its own two feet.”

He thinks China will be able to orchestrate a soft-landing for its economy and what is missing is a co-ordinated and transparent response from the European Central Bank and political action within Europe, he said.