Weekly Market Wrap-Up: Moving On
Brexit has gone through. Although the referendum has no legal standing until Article 50 of the Lisbon Treaty is invoked, and a two-year negotiation process begins, financial markets are re-pricing an exit of the United Kingdom of the European Union. Here in Canada, Brexit should not have come as a total surprise. After all, the Province of Quebec was swept by an orange wave (NDP) in 2011 and a red tsunami (Liberals) in 2015. Populism politics and governments’ dissatisfaction can no longer be taken with a grain of salt. That being said, equities and bond yields have tumbled globally. In fact, US 10-year bond yields are just a fraction higher than the 1.43% low seen through the European sovereign debt crisis in 2012. Gold has pushed through the 1,300 resistance. Unsurprisingly, with world central banks coming to the fort this morning and providing liquidity to global funding markets, odds of a Fed hike in 2016 have plummeted. Otherwise, we believe that the silver lining in this week’s correction is that equity markets’ valuation should not be cause for concern for now, especially in Europe.
Our Chart of the Week features our S&P 500 tactical valuation indicator. It shows that at current levels (2,065), the spread between the index forward P/E ratio (~16.5x) and the CBOE VIX (~21) has fallen near the “-5” level, which marks the “accumulation” zone. As our chart illustrates, improvement has come from lower equity prices, a recovery in the S&P 500 forward EPS estimates in Q2 and a pick-up in volatility (i.e., fear) due to Brexit. Since volatility has become the main swing factor in our indicator, a trip down to 2,000 on the S&P 500 would likely bring the volatility high enough to push the spread between the forward P/E and the VIX below “-10”, the all-clear “buy” zone for US equities. Considering that cash levels in stock portfolios are above average already, the 2,000 level should hold. Otherwise, Mr. Market could be sending a different message than investors have been reading this year.
Regarding economic data this week, Statistics Canada issued an upbeat retail sales report. Up 0.9% MoM and 4.6% YoY, Canadian retail sales got a boost from gasoline stations (+6% MoM in April), furniture and home furnishings stores (+6.1%) as well as building materials, garden equipment and supplies dealers (+1.6%). Also, while rising 8.4% YoY, sales at motor vehicle and parts dealers took a breather in April, declining 0.3% MoM. In the US, durable goods orders declined 2.2% MoM in May but non-defense capital goods (excluding aircraft), fell a more modest 0.7%. On the housing market, the house price index and existing home sales improved 0.2% and 1.8% MoM, respectively. Unfortunately for homebuilders, new home sales and prices were not as exuberant. Indeed, new home sales declined 6% MoM to 551k units. Meanwhile, the median price for new homes hit a 10-month low at $290k, a 9.3% MoM drop. Elsewhere, in Europe, the Markit flash manufacturing PMI improved to 52.6 (from 51.5), while that of services declined to 52.4 (from 53.3). Importantly, both PMIs remain above 50 and suggest improving economic conditions, consistent with the ZEW economic sentiment index settling at 20.2 (from 16.8). Obviously, these business-sentiment indicators should moderate this summer as Brexit uncertainties shift from expectations to reality. Last, in Japan the trade balance deteriorated with exports falling 11.3% YoY (from -10.1%). In all, these statistics support the thesis that the BoJ will infuse the economy with an extra dose of monetary easing.
Next week, we await global manufacturing PMI releases. In the US, personal spending/income, and PCE inflation are on deck. In Europe, we’ll focus on inflation and consumer and business confidence.
In light of the Brexit news and further to Martin Roberge's comments above, we also wanted to highlight a note from Lead Portfolio Manager of GPS and Global Strategist, Robert Jukes.
Don't Leave Me This Way
The UK vote to leave the EU has already driven heightened uncertainty in financial markets with sterling having tumbled to 1985 levels and the FTSE opening roughly 8% down on the news. This negative impact on the stock market and the pound sterling is likely to persist into next week as political and economic vulnerabilities of the vote become clear. Already the level of policy uncertainty in the UK has reached an elevated level, and that is likely to feed through into Europe and the US as the consequent heightened uncertainty around economic growth prospects become clear. We expect global coordination from central banks later today and into next week, the BoE has already announced £250bn to support markets, and SNB has intervened on currency. That said, we remain skeptical about the prospect of monetary policy intervention stimulating growth longer term. The UK is likely to take the brunt of the short term financial fall-out, but longer term we expect Europe to suffer, and a heightened risk of a global slowdown in growth.
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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