Legacy Wealth Weekly - Sept 30, 2016 (Decoupling)

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Weekly Market Wrap-Up: Decoupling

US and Canadian equities went their separate ways this week, thanks to OPEC’s production freeze (more below) which has sent WTI (~8%). US equities have been held back by investor concerns on Deutsche Bank’s (DB) capital position. The fact that Chancellor Merkel is not going to get any support to bail DB out of a potential capital squeeze is not helping things either. Obviously the 2008 financial crisis is still fresh in the memory of investors. Fed Chair Yellen spoke this week and mentioned that the central bank might find itself hitting a ceiling on the amount of U.S. government paper it could purchase. In that case, Yellen said, through the next downturn the Fed could buy corporate bonds and stocks. This probably explains why US investment grades (LQD-US) are the new Treasuries (TLT-US) and high yields (HYG-US) the new investment grades. Today is the last day of the third quarter. In all, despite heightened economic and central bank concerns, stocks have performed well, with the S&P 500 up ~3% and the S&P/TSX ~5%. The standout is DRAM prices (i.e., memory chips) which are up 21%. No wonder the US semiconductor group (SMH-US) has been on fire this year, up nearly 30%.

Our focus this week is on the historical relationship between the CDN$ and oil prices. History shows that there is a very high degree of correlation between the two factors (0.84 over the past 10 years). However, our Chart of the Week shows that, at times, there can be decouplings. Earlier this week, we made the case for such a decoupling in 2017 as oil prices firm and the Loonie reverts to the low 70s. We said that Canada’s weakening fiscal and economic fundamentals would trigger the decoupling. Other contributing factors will be negative spreads between Canadian and US bond yields and the plunge in Latin American currencies. Already, the Mexican peso is down a stunning 16% YTD vs. the CDN$, thanks to Mr. Trump. As a result, Maya oil will compete forcefully with Canada’s oil sands for the US market. This will hurt our trade balance. Already, Mexico and Brazil have grabbed some market share in the US automotive and aerospace markets. Is Canadian oil the next victim?

Regarding economic statistics this week, in Canada, the Federal government budget deficit settled at $1.8B in July (-$9.9B YoY), another bearish signal for the CDN$. A weaker Loonie would help to stir some inflation. For now, producer prices keep falling, with another 0.5% decline (-1.3% YoY) in August. In the US, new home sales declined 7.6% MoM, but that masks a 21% increase from last year’s levels. For their part, durable goods orders came in flat MoM in August but ahead of expectations while non-defense capital goods orders (excluding aircraft) advanced 0.6% MoM. Last, US headline and core PCE inflation improved to 1.0% (from 0.8%) and 1.7% YoY (from 1.6%). As a whole, these statistics support probabilities of a Fed hike in December. Speaking of inflation, in Europe, flash headline and core inflation came in at 0.4% and 0.8% YoY respectively in September (from 0.2% and 0.8%). In Japan, however, inflation remains anchored in deflation territory, with both headline and core indexes registering a 0.5% YoY decline. Meanwhile, consumer spending seems stuck in the doldrums, with retail sales falling 2.1% YoY and household spending plunging 4.6% YoY in August. In China, the Caixin mfg. PMI improved slightly (to 50.1 from 50.0). But statistics in South Korea were more encouraging, with retail sales up 6.0% YoY (from +4.4%) and industrial production +2.3% YoY (from +1.6%).

Next week, we await global PMI releases, the trade balance in Canada as well as US and Canadian employment statistics. Finally, retail sales should help gauge consumers in Europe.

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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