Weekly Market Wrap-Up: Up, Down, Up, Down… by Martin Roberge
The S&P/TSX and the S&P 500 are both nearly flat for the week. There is no real conviction among buyers and sellers as the US earnings season is drawing to a close. Markets will soon enter an earnings void and the macro environment will take center stage. While not much is expected to occur in May, three key market movers loom in June, including the OPEC meeting (June2), the FOMC meeting (June 14-15) and the “Brexit” referendum (June 23). Now that Iran’s oil production is back to pre-sanction levels, it will be interesting to see if the country joins the coalition pushing for a production freeze. Fed presidents Mester, George and Rosengren gave speeches this week. Unsurprisingly, all three pointed to the risk of maintaining rates too low for too long. They also said that financial markets (read bonds) are too negative on the US economy and not pricing risk of faster-than-expected policy normalization adequately. The bond market continues to play deaf ears, with US 10-year bond yields losing another 8bps this week to 1.71%. As such, one would have expected the US$ to fall this week but it rose again and the DXY is now flirting with its 50-day MA.
Many investors wonder whether the rally in gold equities has more firepower. So far this year, the S&P/TSX gold index is up 78%, which is the best YTD start since 1987. While tactically many gold equities look overbought, we tend not to pay attention to the first overbought reading since it usually points to a sentiment change. As such, we believe 2016 could well look like a replay of 1993. Our Chart of the Week overlays the two periods, and similarity in performance is striking. The S&P/TSX gold index rose 110% in 1993. The common backdrop between the two episodes is a slow-moving Fed which allows inflation expectations to build. Bond yields are anchored down by the Fed, while inflation moves up, fueled by a weaker US$, a rebound in commodity prices and firmer economic growth. The decline in real bond yields fuels the gold rally until the Fed strikes and the bond market collapses. Ask your colleagues on the bond desk about 1994! This is our scare for Friday the 13th.
Regarding economic data this week, in Canada, StatsCan’s annual Capital and Repair Expenditures Survey for 2016 paints a bleak outlook, with overall spending expected to decline 4.4% (-9.3% for the private sector vs. +6.5% for the public sector). Fortunately, the housing market remains buoyant, with the new housing price index up 2% YoY (from 1.8%) and the Teranet-National Bank house price index up 8.1% YoY, thanks to the Toronto and Vancouver markets. In the US, retail sales look strong across the board, up 1.3% MoM in April for an annual growth rate of 3.0% (from 1.7%). That looks consistent with the improvement of the Michigan Consumer Sentiment index (95.8 in May, from 89). Among other good news, headline and core producer prices both grew MoM to settle at 0.1% and 0.9% YoY respectively. Elsewhere, in Europe, industrial production declined 0.8% MoM, resulting in a weak but still positive 0.2% YoY growth (from 1%). In China, export growth slipped back into negative territory (-1.8% YoY from +11.5%) while imports further weakened (-10.9% YoY from -7.6%). Inflation declined 0.2% MoM but remains stable at +2.3% on a YoY basis. Otherwise, April producer prices registered a 50th consecutive month of YoY declines but improved somewhat, down 3.4% YoY. In India, industrial and manufacturing production both dropped to 0.1% YoY (from 2.0%) and -1.2% YoY (from +0.7%). Unfortunately, inflation increased to 5.4% from 4.8% in March, not a good combination for the RBI.
For next week, in Canada, we await inflation, retail sales and manufacturing sales. In the US, inflation, industrial production and several housing statistics are on deck. Finally, in China, investors are likely to pay attention to industrial production, retail sales and home prices.
May Strategy Picture Book by Tony Dwyer
The “Fantastic Four” suggest 15-20% upside over next 6-12 months. We look at how historically important the turn in February was based on the improvement in market breadth and corporate credit. It is very difficult to have a high near-term conviction level as we approach the June 2 OPEC meeting, June 14-15 FOMC meeting, and the June 23 UK Referendum (Brexit) vote. That said, the two key market issues early in 2016 – poor market breadth and spiking corporate bond-yields – have reversed to a degree that suggests they have become major historical buy signals. The problem rests in maintaining the trust in the indicators when the selling finally shows up:
- Breadth Thrust Like March 30 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 19 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 8 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 1 Suggests 17.8% Gain. Again, since 1970, when the SPX went up enough and the Moody’s BAA corporate bond yield dropped enough to drive the 10-week ROC, it was a great SPX buy signal.
Three key indicators suggest no U.S. recession likely through 2017. Since the 1950s, there has not been a recession with (1) the Real Fed Funds rate reaching over 2%, (2) an inversion of the U.S. Treasury Yield Curve, and (3) the Chicago Fed National Financial Conditions showing elevated levels of systemic stress. We point this out because even if the Fed is “pushing on a string” and doesn’t matter anymore, surely there would be signs of stress in the system, yet there are none.
Core thesis helps us maintain conviction during correction/consolidation period. Our core thesis is that (1) core inflation drives Fed policy, (2) Fed policy drives the slope of the yield curve and availability of money, (3) the yield curve drives economic activity, (4) economic activity drives EPS, and (5) EPS drives the market.
- Easy Fed and yield curve. The Fed has taken a much more dovish view with only two rate hike expectations this year, while the market view even less.
- Expect moderate growth to continue. We expect the tailwinds of (a) historic global monetary accommodation, (b) stable commodities and emerging currencies, (c) positive trending U.S. economic growth, and (d) an inflection in the global economy.
Valuations should still move higher. When core inflation is between 1-3%, the average SPX operating EPS valuation is 19x. Given the current global headwinds, our 2016 target of 2,175 is based on 18x $121 in EPS.
The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.
Legacy Wealth Partners