Weekly Market Wrap-Up: The Dust Settles
Equity markets in North America (NA) have recouped most of their losses following the UK Brexit vote. Whether it is investors coming to the conclusion that Brexit is a political tremor rather than an economic/credit shock, or simply that risk assets will enjoy hyper-stimulative conditions for longer, the S&P/TSX and S&P 500 are now less than 1% below last Friday’s peak. Bond yields, however, have not rebounded with equities, as Brexit led many economic organisations to lower their outlook for global growth by 0.3%-0.5% for 2016-17. Strangely enough, corporate bond yields dropped across the risk spectrum this week. In fact, US Moody’s BAA corporate bond yields fell to a new 52-week low at 4.41%. This is only 12bps above the July 2015 all-time low of 4.29%. Last, the post-Brexit US$ depreciation jolted “risk-on” commodities such as oil and copper prices. Surprisingly, gold has remained flat. While lower real bond yields help, we suspect that quarter-end window-dressing activities played a big role in keeping the bullion afloat.
As we explained Wednesday, we believe Brexit should maintain or lead to over-stimulative conditions that in the medium term should support risk assets such as corporate debt, commodities and equities. In fact, after European sovereigns and corporates, our view is that NA corporate investment grades are headed to bubble land. Emerging market (EM) debt is not too far behind, which bodes well for EM proxies such as Canadian equities and commodities. Long-term and passive investors such as pension funds and life insurance companies are facing limited alternatives to earn their ROA and/or hedge their liabilities, hence a sustained appetite for higher-risk debt instruments going forward. This prospect may seem at odds with global political and economic uncertainties. However, as our Chart of the Week shows, this is exactly what occurred through the 2011-12 European debt crisis. In fact, new bond yields lows on corporate BAAs sowed the seeds of a powerful equity rally that began in summer 2012. Is a similar roadmap in the cards for NA stocks? Food for thought.
Regarding economic data this week, in Canada, higher commodity prices allowed producer prices to advance 1.1% MoM (-1.1 YoY from -1.6%) in May. In the US, headline PCE inflation declined slightly to 0.9% YoY (from 1.1%) in May while core PCE inflation remained unchanged at 1.6%. While inflation should accelerate in H2/16 owing to higher oil prices, it should remain much below the Fed’s objective of 2%. Meanwhile, personal income missed consensus with a 0.2% MoM increase in May (vs. 0.3% exp.) but personal spending rose as expected (+0.4%) and should continue to improve if the Conference Board Consumer Confidence index is any guide (98 reading in June, from 92.4). On housing, the Case/Shiller home price index increased 1.1% MoM in April (5.4% YoY from 5.5%) but pending home sales sent a more bearish signal with a 3.7% MoM drop in May. Elsewhere, in Europe, loan growth accelerated to 1.6% YoY in May (from 1.5%). This shows that ECB initiatives so far have succeeded in improving banks’ propensity to lend. However, inflation remains anaemic and far from the ECB objective. Indeed, while improving slightly, flash readings for June headline and core inflation in Europe settled at 0.1% YoY (from -0.1%) and +0.9% (from 0.8%). European sentiment measures also disappointed this week with a worsening of overall economic sentiment (104.4 from 104.6) and consumer confidence (-7.3 from -7). Brexit should cause sentiment to deteriorate this summer.
Next week, we await service and manufacturing PMI releases globally as well as the trade balance, building permits, housing starts and employment statistics in Canada. Elsewhere, we will focus on US nonfarm payrolls, retail sales in Europe and inflation in Japan.
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