Legacy Wealth Weekly - September 4, 2015 (Testing Lows, September Markets and Monetary Policy)

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U.S. Portfolio Strategist Tony Dwyer made a very bullish call last week. Despite the call, he noted the market rarely makes a “v” bottom, especially following such a sharp correction associated with a historic spike in volatility as measured by the CBOE Volatility Index (VIX). Indeed, last Tuesday’s low was followed by a swift 6.5% rally in the S&P 500 (SPX), and it appears we are now in the “normal” process of the initial retesting of the 1867 low.

North American Portfolio Strategist Martin Roberge notes the S&P/TSX and the S&P 500 dropped this week, the latter flirting with the 10% correction mark again. When dealing with emotionally charged markets, some backing and filling is the norm, not the exception. Market volatility remains mired around Chinese economic concerns as we learned that manufacturing is still softening. Also, there are perceptions that the Fed could make a policy mistake if it was to hike rates in two weeks. With ECB President Draghi mentioning that a more aggressive QE is an option should conditions warrant such a response, the risk is a relentless bull charge in the US$. Already, US financial conditions are very tight with bond yields, credit spreads and the US$ rising this summer. In fact, many economists are now talking about “quantitative tightening” as some EM central banks may be selling US Treasuries to slow/halt domestic currency depreciation. In the case of several Asian currencies, the rapid depreciation observed this week is unnerving.

Martin reiterates his view that DM policy rates are zero bound, the world economy has entered a new regime where the onus is on EM central banks to support and stimulate global growth. Fortunately, the EM monetary toolbox is still full with policy rates averaging 5%, a level still above the average inflation rate at 4%. The risk in Martin’s view for the global economy is that EM real lending rates remain too high for too long. Over the next several years, we believe the PBoC in China and the RBI in India will have to replace the Fed and the ECB as circuit breakers for the world economy. Encouragingly, the PBoC acted forcefully last month by cutting RRRs and lending rates. The RBI should follow suit later in September as inflationary pressures are receding fast in India. Contrary to widespread beliefs, the world economy appears to be stabilizing from the slowdown seen in H1. As such, further EM policy responses, the lagged impact of earlier rate cuts and lower oil prices represent potent shock absorbers which should shift investors’ gloomy sentiment on the global economy. As for the Fed, it should hike in September to end the “expectation” phase and remove the uncertainty. The Fed can neutralize perceptions of a policy mistake by taking its dot-plot down to the bond market expectations.

The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter,click here.


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