Europe returns to growth
Europe took centre stage this week and it was for all the right reasons. There has been much hand-wringing over the lack of inflation and growth on the continent for months but Wednesday the European Union reported GDP euro-zone growth expanded 1.6% on an annualized basis during Q1. That bested growth expectations in the US and UK over the same period providing powerful evidence that stimulus efforts are working. The good news left traders fidgety however as they worry the news may be good enough to end the ECB’s massive 60-million euro a month bond purchase program. To counter fears, ECB President Mario Draghi said Thursday that the bank’s stimulus efforts will continue “as long as needed” until their objectives have been met. Also in Europe, the Greek government made good on its pledge to meet a debt payment this week but it also officially fell into recession in the first quarter which suggests recent moves to alter its refinancing arrangements are impacting the economy. Elsewhere, the Peoples Bank of China (PBOC) cut interest rates a quarter percentage point Sunday, the third time in six months the central bank has cut rates to spur growth. The most recent cut comes on the heels of a range of targeted measures to try and stimulate lending to private businesses. Finally, Moody’s cut its growth expectations for Canada putting it in a range of 1.5% to 2.5% this year making it the latest of many to reduce targets after the steep drop in the price of oil. That leaves the Bank of Canada as the outlier when it comes to growth expectations as it has predicted 1.9% in 2015 and 2.5% next year.
US stocks rise
For the four-day period covered in this report, the Dow rose 61 pts. to close at 18,252, the S&P 500 added 11 pts. to finish at 2,127 and the Nasdaq moved ahead 47 pts. to settle at 5,050. The TSX was the only money loser through Thursday closing down 142 pts. to end at 15,028.
Remaining short duration and defensive
Fixed Income: Andy Mystic, Director, Portfolio Advisory Group wrote: “So far this year we have continued to advocate for a segmented approach to fixed income. In the early part of the year, as rates trended lower and markets braced for another potential Bank of Canada rate cut, we suggested investors focus on GICs in the 1-5 year area, higher grade, liquid provincial credits (particularly Ontario and Quebec) in 5s-10s, and potentially look to engage tactical trades at the longer end of the yield curve (Canadian government bonds or US Treasuries). This positioning, we believed, would provide maximum liquidity/flexibility in the event that rates began to unwind, as indeed they have. Until rate markets begin to demonstrate a more persistent trend, investors should remain short duration (i.e. reducing/closing exposures in the long end and middle part of the curve) and defensive. We remain cautious on High Yield (HY), particularly in the energy space as the current risk/reward proposition appears inadequate to us. The potential impact of secularly rising interest rates and rising default rates, if relatively low oil prices persist, suggests that HY spreads remain too low.”
A comment by US Fed Chairwoman Janet Yellen about stock valuations was the news-making event of the week as it tapped into lingering fears the current bull market may be getting ahead of itself. Yellen said stock valuations were “quite high” at International Monetary Fund headquarters Wednesday. That rattled US, European and Japanese equity markets which sold off before paring losses by Thursday close. Canadian equities got a jolt of their own but for a different reason; a surprise win by the NDP party in Alberta whose policies may crimp energy profits. On a more positive note, European Union economists said cheaper oil and central bank stimulus could deliver faster growth in the region this year. GDP predictions in the 19-nation euro zone now stand at 1.5% for the year, up from a previous estimate of 1.3%. The forecast for the larger 28-nation EU is 1.8% up from 1.7% in February. Ireland and Spain are pegged to grow the fastest while Greece the slowest. Greece, as Market Watchers know, is stuck in a long fight with its creditors to loosen conditions tied to its bailout agreement. Once again, there’s talk of a default and exit from the single currency union but there’s been so many make-or-break moments it’s looking more and more like brinkmanship. The country must make a 750 million euro payment May 12 – a payment the Greek finance minister has pledged to make. In the UK, the Conservative Party rode to victory in the British general election Thursday in what political commentators called a surprise win. Closer to home, US equity trading volumes were light this week ahead of the employment report due today (May 8). The jobs report is always a primary focus but April’s has taken on greater significance as it may help determine whether the disappointingly weak first-quarter GDP data was a blip or a sign of bigger problems. Estimates for the number of US jobs created last month stand at 228,000 while the unemployment rate is expected to tick down to 5.4% from 5.5%.
Stocks fall for second week
North American stock benchmarks ended the four-day period in the red for the second week in a row. The Dow fell 110 pts. to close at 17,924, the S&P 500 shed 30 pts. to finish at 2,088 and the Nasdaq gave back 60 pts. to close Thursday at 4,945. The TSX was down 249 pts. to end at 15,088.
Uncertainty in the Canadian energy patch
Equites: Himalaya Jain, Director, Portfolio Advisory Group wrote: “With regards to the NDP win in Alberta, the bottom line is that changes are coming and these changes will be incrementally negative for Canadian energy producers operating in Alberta. That’s the simple part. What is quite unclear is the extent of increase in royalty and tax rates and implementation timing. This week’s share price moves, while knee-jerk, were likely reasonable. Meanwhile, as the market digested the NDP win in Alberta, weekly US crude inventories declined (versus expectations of a build) and total US oil production was flat week-over-week and down from the mid-March peak. This is exactly what we’ve been expecting as the 55% decline in US drilling activity since Nov 2014 is finally starting to show up in the production numbers. Another anecdote that is supportive of oil prices, but supports our view that further job cuts are coming in the oil patch, was the April Challenger US job cuts that showed April layoffs were at a four-year high and that one-third of the cuts were in the energy sector. Spring break-up in Canada’s oil patch combined with negative sentiment from the NDP win means that further job losses in Alberta are coming and could pull down the national job picture in Canada.”
A first-quarter stumble in US GDP growth drove the narrative this week as it pushed back expectations of a Fed rate hike. News that the US economy grew just 0.2% during the first three months of the year was well below expectations and comes on the heels of other less than supportive growth and earnings data. The Fed, which met mid-week for a two-day policy meeting, said the dimming growth has given it pause when it comes to the timing and mechanics of an interest rate increase. But they also said the slow growth patch was viewed as temporary and data released near week’s end seemed to confirm that view. US labour costs did, for instance, solidly rise for the first three months of the year while jobless benefits tumbled to a 15-year low last week. Jobless claims and wage growth are two key measures watched by the Fed. A third important yardstick is inflation and it undershot the Fed’s 2% target for the 35th month straight. In fact, the personal consumption expenditures price index moved just 0.3% year-over-year through March. Also in the US, Japanese PM Shinzo Abe and President Obama re-iterated their twin desires to get a Pacific free-trade pact signed even as opposition remains firm among Congressional Democrats. Turning to the Greek debt drama, there was an unusual level of flexibility shown by the ECB Thursday as the bank agreed to help the country avoid a cash crunch if there was an agreement in sight on sustained financial support. Finally, euro zone prices stopped falling for the first time since last December easing fears that the continent may not be headed into a deflationary spiral. Looking ahead, Britons will go to the polls next Thursday to choose a new government with commentators saying it could be the tightest vote in decades.
For the four-day period covered in this report, the Dow fell 240 pts. to close at 17,840, the Nasdaq gave back 151pts. to finish at 4,941and the S&P 500 slipped 32 pts. to finish at 2,085. The TSX also ended the week lower as it fell 184 pts. to end Thursday’s session at 15,224.
Fixed income volatility rising – be defensive
Fixed Income: Andrew Mystic, Director, Portfolio Advisory Group wrote: “Bond markets have recently become more vulnerable as a combination of reversing European rate levels (i.e. moving higher), seemingly more hawkish comments from the Bank of Canada, and expectations for transitory Q1/15 growth softness in the US – have conspired to send North American rates higher. Although inflation remains somewhat low, gently rising oil prices, seemingly stable core readings and a more constructive labor market (unemployment 5.5%; claims levels lowest in 15 years; ECI wages 2.8% y/y), are affording investors some rationale to believe that the US could actually achieve escape velocity this year. Having said all this, there remains a relatively high disparity in views which should continue to spur volatility. Investors should become increasingly defensive, shortening duration, raising cash and reducing low grade credit exposures.”