The Fantastic Four by Tony Dwyer
After traveling around North America in recent weeks, we believe the only consensus is that there is no consensus. While many recognize the economy is likely to avoid a recession, they are hesitant to chase equities higher following a 15% rally in the S&P 500 (SPX) off the February 11th low. While remaining fundamentally bullish, over the past few weeks we have recommended a neutral near-term market and sector position as we get through the uncertainty of June. In June, investors will have to grapple with (1) the postponed OPEC decision, (2) the quarterly Fed meeting, and (3) the UK Referendum (Brexit). With volatility near the lower end of its historic range following the sharp rally in equities, emerging currencies, and corporate credit, there remains the potential for a bout of profit taking as we approach and move through these June events.
The “Fantastic Four” give confidence to buy any weakness. The trick in a fundamentally driven bull market as highlighted in our April Strategy Picture Book isn’t expecting a correction, but is actually buying it as fear mounts. We give you these four historical indicators BEFORE any weakness in the hope that it will enable fundamentally driven buyers to not panic and use the weakness to their advantage.
- Individual stock breadth thrust like March 30th suggests 16.2% gain. Whenever more than 90% of the market is trading above their respective 50-day moving averages, the SPX has not been down a year later.
- Sector reversals like April 19th suggest 15.1% gain. Over the past 25 years, when all 10 SPX sectors have gone from under to above their respective 200-day moving averages, the SPX rose a median 15.1% over the next 73 business days.
- Corporate bond surge like April 8th suggests 21.3% gain. Since 1970, anytime the yield on the Moody’s BAA Index saw a 10-week rate-of-change of minus 10 or below, there was never a negative 6 or 12-month SPX return.
- Stock/bond ratio ramp April 1st suggests 17.8% gain. Again, since 1970, when the SPX and Moody’s BAA corporate bond yield ratio rose enough to drive the 10-week ROC to 20, it was a great SPX buy signal.
Summary. Buy any weakness as we move toward June events. We find it interesting that every time the market goes down, it is telling us something, but every time it goes up it represents a foolish mistake. The main reason many used for expecting a recession and major market decline – bad market breadth and spiking corporate bond yields – have reversed to the point where they generated signals for above normal SPX gains. For us, a change in trend is not seen when the markets experience their first oversold bounce, but is more identifiable during the consolidation/correction period after the initial ramp off a historic low. Our 2016 target remains 2,175, which assumes an 18 multiple on $121 in SPX operating EPS.
Assessing the impact of a stronger Loonie by Tony Dwyer
The global financial market chaos that was set off by the U.S. Fed rate hike in December has clearly stabilized and reversed. Despite how well telegraphed the initial move off the zero interest rate policy (ZIRP) in the U.S. had been, it was followed by dramatic commodity price weakness (especially for Oil), a Chinese currency devaluation, and severe pressure in the corporate fixed income markets. Since making a major low in the first part of 1Q16, those areas hit by the panic sell-off have fully reversed, causing many to wonder if the gains were sustainable, or just another oversold rally that should be faded.
We believe the sharpness of the decline in the financial markets, and especially the “commodity currencies” such as the Canadian Dollar, was largely overdone, and therefore we expect the gains to be sustainable. This is hugely important to North American investing because (1) at 19%, Canada is the largest export market for the U.S. (Figure 1), and (2) as of the turn of this decade, 73% of Canada’s exports went to the U.S. and 63% of Canada’s imports were from the U.S. Clearly, a large portion of the close business relationship has to do with energy. Indeed, as Anthony Petrucci points out, over the past 20 years, the correlation coefficient between the Canadian Dollar and oil prices has been 0.94. As a result, for stability in commodity currencies, there needs to be stability in commodities – especially important for the Canadian Dollar.
Although we expect some degree of near-term volatility associated with the “Brexit” vote and U.S. Fed rate decision in June, we believe there are three reasons why the sharp gain off the early year low in the Canadian Dollar should be sustainable:
- Purchasing Power Parity (PPP) shows the U.S. Dollar is still overvalued vs. the Canadian Dollar (Figure 2). According to our friends at Ned Davis Research, the PPP using the long-run averaging approach of historical and current inflation shows the U.S. Dollar is 18.9% overvalued despite the recent ramp in the C$.
- History of major turns in oil price suggests the low is in. In January, Oil jumped 10% or more in two days from a one-year low. Of the four prior occurrences, it marked a major long-term bottom. Prior occurrences were 1986, 1990, 1998, and 2008.
- Sharpness of Canadian Dollar rally points to further intermediate-term gains. We measure the sharpness of rally by the 10-week rate-of-change (ROC). Over the past 30 years, any time the 10-week ROC reached current levels, there was a pause in the upside, but further gains over the intermediate term (Figure 3). Prior occurrences were 06/03, 11/04, 06/07, 05/09, and a few weeks ago.
Summary: We expect a consolidation/correction in some of the recent gains in the Canadian Dollar and other Emerging currencies, but we believe the recent gains should be sustainable and further intermediate-term gains should be expected. – Tony Dwyer, U.S. Portfolio Strategist
In this report, Canaccord Genuity’s energy, metals, financials, healthcare and TMT analysts analyze the impact of the rising Canadian dollar which is up 10% YTD against the U.S. dollar. For the energy sector, the improving Canadian dollar would appear to hamper cash flows but in reality is highly correlated with the rise in oil prices. While both bank and lifeco earnings are hurt by the rising C$, we believe that the negative impact is greater on lifecos. We conclude that a stronger Canadian dollar is generally a negative for Canadian technology companies For metals, the impact is mixed due to multi-jurisdictional assets. We conclude that all things being equal, mining companies with the highest percentage of their costs allocated in the weakest currencies should enjoy the greatest operating leverage. Consequently, the rising C$ is negative for producers with largely Canadian mining assets. – Dvai Ghose, Global Head of Equity Research
When Doves Cry by Robert Jukes
“This is what it sounds like…”, when policy makers concerned about growth start to run out of ideas. These tears were visible across the world as equity markets rebelled furiously after the inaction from the Bank of Japan (BOJ) at their April meeting. No further interest rate cuts and no additions to the asset purchase program of Quantitative Easing (QE). The former is likely to be the result of a growing realization that Negative Interest Rate Policies (NIRP) have gone about as far as they can, negative interest rates have hit a practical floor, and may actually be harmful to growth going forward rather than stimulating it.
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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