The US Federal Reserve and its decision to move slowly on interest rate increases was the marquis event of the week. The Federal Open Market Committee dropped its promise to be ‘patient’ when it comes to the timing and mechanics of an interest rate increase but they also made it clear they were in no hurry. The lack of urgency stems from a soaring US dollar and recent economic data – falling retail sales, near idle-inflation and slowing growth –which has not been supportive of an interest rate increase. So while the Fed may no longer be ‘patient’ it appears it won’t be impatient either. Traders cheered the move as many expected more aggressive action on rate increases and the prospect of lower rates longer bodes well for stocks. Elsewhere, the Organization for Economic Co-operation and Development (OECD) has cut its forecasts for 2015 and 2016 Canadian economic growth taking them down to 2.2% this year and 2.1% next year; that’s 0.4% and 0.3% less than originally thought, respectively. The reason for the downgrade stems from the sharp drop in the price of oil which is anticipated to reduce growth in Canada. On the flipside, the OECD has raised its projections for global growth as the falling price of crude reduces corporate costs and raises household incomes. Finally, details are still being worked out by Greece and its creditors following the agreement to extend the country’s US$254 billion bailout through the end of June. The decision to extend the bailout hinged on Greece enacting reform measures which it has not done. That’s gotten the attention of euro power broker German Chancellor Angela Merkel who has directly intervened and invited the Greek leader to meet with her face to face Monday.
Major North American stock benchmarks ended the four-day period covered in this report higher. The Dow added 210 pts. to close at 17,959, the S&P 500 gained 46 pts. to close at 2,089 and the Nasdaq jumped 121 pts. to settle at 4,992. The TSX ended Thursday 142 pts. higher at 14,873.
Who Let the Doves Out? The Fed Increases Its Flexibility While Taking a Dovish Turn This Week
Fixed Income: Andrew Mystic, Director, Portfolio Advisory Group wrote: “North American central banks continue to surprise with the FOMC this week affording itself more flexibility but turning decidedly more dovish in its forecasts. Although the Fed increased its flexibility by dropping the word ‘patient’ from its formal statement, it seemingly took a dovish turn which limited market expectations for the pace and final level of rates over the forecast period. In removing the word ‘patient’ from its statement the FOMC did increase its flexibility to act as elimination of the word was seen by many to be a necessary precondition to potential rate liftoff. The Fed however surprised markets by lowering rate and growth forecast expectations aggressively. The FOMC revised its median ‘dot plot’ forecast effectively signalling that it only expects to raise its target rate by about 50 basis points in 2015. The median forecast expectation has now fallen to 0.625% in 2015 (prior was 1.125%); 1.875% in 2016 (prior was 2.5%) and 3.125% in 2017 (prior was 3.625%) – the long run 3.75% remains the same as the December forecast. As well, the Fed lowered both growth and inflation expectations, although unemployment forecasts were also lowered. Adding to this constructive rates outlook is the expectation that the Bank of Canada could again cut rates later in the year if sufficient growth fails to materialize. European rates will likely continue to support lower rates globally – all of which likely continues to be positive for bond markets.”
Volatility returned this week as worries increased about the timing and mechanics of an interest rate rise south of the border. A Fed rate hike has been expected but last Friday’s strong jobs report ratcheted up concerns that this eventuality had grown closer. Adding to rate hike concerns are jitters about the soaring US dollar and oil prices that may still turn lower. It was almost with a sense of relief that US retail sales disappointed for the third month in row. They fell 0.6% in February after dropping 0.8% in January and 0.9% in December. Retail sales had been expected to rise as the price of gas fell but it appears snowy, cold weather may have kept shoppers indoors. The lack of improvement in retail data is the kind of development that may make the Fed pause as consumer spending is a key driver of GDP. The level of inflation and its direction are other key inputs into Fed rate decision making so it will be interesting to see US Producer Price Index data released today (March 13). Elsewhere, the IMF boosted its growth projections for India with the country expected to deliver 7.2% growth for the current year ending March 31 and 7.5% for the following year. Both estimates top the 2014 actual and 2015 projected numbers for China, which comes as a bit of a surprise. Meantime, euro zone finance ministers met to discuss reform proposals submitted by Greece last week in a bid to unlock further financial aid from creditors. Finally, the ECB completed about US$10 billion worth of bond buying in the first three days of its massive stimulus program.
Stocks end mixed
Although the Dow moved 100 pts. or more three times in the last four sessions it ended Thursday up a modest 39 pts. to close at 17,895. The S&P 500 shed 6 pts. to settle at 2,065, the Nasdaq gave back 34 pts. to end at 4,893 and the TSX fell 182 pts. to finish at 14,770.
Divergent policy could stir volatility
Fixed Income: Andrew Mystic, Director, Portfolio Advisory Group wrote: “Divergent monetary policy in Canada and the US could stir further fixed income volatility over the coming months as expectations for potentially higher rates in the front end of the US curve plays out against a more dovish Bank of Canada. With Scotiabank Economics forecast calling for CAD to trade down another 4% from current levels, we think there remains further spread support for the eastern provinces – as a weaker CAD should likely spur manufacturing activity. Our view of the bond market is three pronged: (1) in the one to five year range there is really no product that compensates investors better than GICs and we continue to favour them relative to spread product, (2) in the five to 10 year space, where investors could potentially benefit from further BoC rate cut(s) and potential spread tightening in the eastern provinces, we would favor liquid provincials – particularly Ontario and Quebec, and (3) at the long end of the yield curve, low inflation expectations and geopolitical risks continue to support the argument for tactical Treasury and Canada rates trades. Expectations for a stronger USD and greater volatility of US rates market suggests that Treasuries could provide a higher alpha trade.”
Central bankers dominated the news this week as the heads of many of the world’s largest banks took steps to stimulate growth and boost inflation. European Central Bank (ECB) President Mario Draghi announced Thursday that the bank’s 60-billion euro per month bond-buying program will begin March 9. Interestingly, Draghi has said he will even buy negative yield bonds which prompted one French utility company to issue two-year corporate bonds Wednesday that pay 0% interest. Meantime, the Reserve Bank of India (RBI) cut its key lending rate for the second time this year taking it from 7.75% to 7.5%. India’s moves come on the heels of a Chinese rate cut last weekend that shaved a quarter of a percentage point off benchmark lending and deposit rates. The benchmark lending rate now stands at 5.35% down from 5.6% while the deposit rate has come down from 2.75% to 2.5%. China’s rate cuts preceded an announcement that the world’s second largest economy is lowering its growth forecast for 2015 to 7%; down from last year’s 7.5% target which the country missed. China and India are part of a growing number of central bankers – Canada included – who have cut rates of late to rev growth and consumer prices. The Bank of Canada met this week but did not lower rates as it did in January. Turning to economic news, Canadian GDP came in at an annualized 2.4% in the fourth quarter 2014 and a 2.5% rate for the entire year. In the US, the economic calendar was fairly light with an ISM manufacturing gauge falling Monday and jobless claims rising more than expected. The most-watched numbers of the week are contained in today’s (March 6) government employment report which is released the first Friday of every new month. The unemployment rate is expected to tick down to 5.6%
Stocks end mixed
For the four-day period covered in this report, the Dow rose 3 pts. to close at 18,135, the S&P 500 gave back 3 pts. settling at 2,101and the Nasdaq added 19 pts. to close at 4,982. Notably, the Nasdaq climbed above the 5,000 pt. level Tuesday for the first time since 2000. In Canada, the TSX gave back 131 pts. to end Thursday’s session at 15,103.
Difficult times navigating capital markets amidst heightened geopolitical risks and relatively high valuations
Equities: Himalaya Jain, Director, Portfolio Advisory Group wrote: “Although the risk-return equation continues to favour the equity market in the medium-term, we are concerned that elevated valuations combined with a worsening of geopolitical risks have made the equity market moderately less attractive in the near-term. In particular, we expect volatility to return as the US Federal Reserve gets closer to raising rates, Greece’s four-month debt extension expires, and the heat gets turned up a notch in various global hotspots. At a P/E of 17.2x forward 12-month earnings for the S&P500, we think the US equity market is less compelling for new money, but we would remain invested because expectations of a stronger USD could further boost CAD-denominated returns this year. Selective opportunities exist in the US healthcare, industrial, and financial sectors. The equity market tone in Canada has improved as oil prices have likely bottomed out and should gradually improve and the Canadian banks reported better than expected Q1 results. As we expect continued headwinds for the Canadian economy, we suggest investors be more selective and patient in deploying new money. Consistent with our strategy of being selective, we continue to recommend overweighting companies with large exposure to the US economy.”
With the price of oil finding some stability this week all eyes turned to the conflict in Ukraine where a truce was reached Thursday morning. The truce was brokered by the leaders of France, Germany and Russia who engineered a ceasefire due to take effect February 15 at midnight. Although the deal ends the fighting between Ukraine and pro-Russian separatists it does not settle the issue of borders which could prove to be its undoing. There also appeared to be forward progress between Greece and its creditors over debt repayments, economic overhauls and budget cuts. The Greek finance minister and 19 other euro zone finance chiefs initially came to an agreement that extended the country’s bailout program but Greece withdrew at the last minute. Talks are expected to resume. Elsewhere, figures released Sunday by China showed surprisingly weak trade data as exports were up a scant 3.3% in January from a year ago while imports fell 19.9%. And in the US, retail sales fell for the second month in a row dropping 0.8% in January. The fall comes despite the savings from sharply lower gas prices, which is surprising some analysts. Finally, the price of West Texas Intermediate oil appears to be finding a floor around the US$50 a barrel mark but it’s unclear whether that will hold and for how long. On Wednesday, the US Energy Information Administration said there is more oil in storage – 417 million barrels – than at any time in its 33-year record-keeping history which helps explain why the number of new wells drilled across the US dropped 28% in January versus last June.
Stocks rise, milestones near
For the four-day period covered in this report, the Dow added 148 pts. to close at 17,972, the S&P 500 moved ahead 33 pts to finish at 2,088 and the Nasdaq advanced 113 pts. to settle at 4,857. Pricing milestones near for the Nasdaq and Dow thanks to the current bull market as the tech-laden Nasdaq is now within shooting distance of the 5,000 pt. plateau while 18,000 is within reach for the blue chips. In Canada, the TSX ended the week positive rising 145 pts. to close Thursday’s session at 15,228.
We’re warming up to oil; fixed income and preferreds to remain volatile as another rate cut is expected
Equity: Himalaya Jain, Director, Portfolio Advisory Group wrote: “There is still a ~2 million barrel/day surplus globally, but we think the foundations of a meaningful supply response have been laid by non-OPEC producers, particularly in North America. Dramatic capital expenditure cuts announced by energy producers since the oil price slide started in October has resulted in US drilling activity that is 25% lower than the November peak. In Canada, the seasonal winter surge in drilling is nonexistent as drilling rig activity is running 39% lower than last year. With the path toward flatter North American production now more visible, we are becoming more constructive on energy equities. Our investment strategy during the past few months had been to high-grade energy exposure by trading sideways into the highest quality producers (integrated and senior producers), while maintaining an overall market weight exposure to energy. This defensive strategy has proven to be worthwhile as many of these equities have recovered most of their earlier losses. However, with many of these equities now discounting US$70-US$80/bbl oil, we think it’s time to begin shifting to an offensive strategy by slowly returning to intermediate and junior producers which remain well below September 2014 levels. However, with balance sheets and dividend policies still on unstable terrain, we prefer to add this exposure via an ETF rather than selecting individual names. While the oil services sector could eventually experience significant torque under an oil price recovery scenario we are not ready yet to venture into this subsector.”