Financial Market Performance & Comments - Month/Quarter Ended September 30th, 2016
Dymond Scruton Advisory Group - Oct 03, 2016
US and Canadian equities went their separate ways this week, thanks to OPEC’s production freeze which has sent oil, WTI up +8%. US equities have been held back by investor concerns on Deutsche Bank’s (DB) capital position. The fact that Chancellor Me
US and Canadian equities went their separate ways this week, thanks to OPEC’s production freeze which has sent oil, WTI up +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 grade bonds (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 up +5% this quarter.
For some perspective on how these numbers impact portfolio strategy, please see the summary below of the monthly comments from our Institutional Portfolio Strategist, Martin Roberge.
The Quantitative Strategist | October 2016 - Martin Roberge
Global economy – A desynchronized world. The good news is that for the first time since 2009, the composite leading economic indicator (LEI) for BRIC (i.e., Brazil, Russia, India and China) countries has pushed into the expansion territory. Central banks in emerging markets (EMs) are pressing hard on the monetary reflation pedal to kick-start growth. Their efforts are bearing fruit. The bad news is that the LEI for the G7 countries remains in the contraction zone and monetary policy as a stimulative tool is nearly exhausted. The net result is a desynchronized world economic cycle which should persist until governments in the developed markets (DMs) embrace fiscal reflation. We believe this pivot point is approaching no matter the outcome of the US presidential election. It is just common sense. The cost of debt associated with government spending is nil as Treasury bond yields in most countries remain below trend GDP growth rates. At a minimum, reducing fiscal drag should be a priority among world governmental authorities in 2017.
Asset mix – time to raise US$ exposure… again. We are moving the 10% in our cash allocation into US$ short-term T-Bills (BIL-US). After taking a positive view on the CDN$ at the beginning of the year, we now believe that the cyclical rally is maturing. Our view is that a relapse to the low 70s is in the cards for 2017 despite firming oil prices and EM’s positive economic momentum. While these factors are normally CDN$ supportive, at times, a decoupling can occur. We believe Canada’s weakening fiscal and economic fundamentals will trigger this decoupling. Other contributing factors are the negative Canada-US bond yield spreads and the plunge in Latin American currencies, notably the Mexican peso. On equities, we maintain benchmark allocations in the near term with a pro-cyclical sector strategy. In the medium term, we have built the optimistic case for stocks by taking our end-of-cycle bond yield range down to 1.50-2.25%. We don’t plan to go any lower. Using a terminal equity risk-premium at 3.5% and consensus EPS estimates, our 12-month fair value estimates for the S&P 500 and the S&P/TSX climb to 2,369 and 15,857, respectively.
Sector rotation – BRIC LEIs and OPEC to prolong the rally in resource cyclicals. Many of our key investment themes have played out this year. First, the transition from DM to EM monetary reflation has occurred. Second, EM growth has reaccelerated. Third, the US$ has stayed flat. And fourth, commodity prices have firmed through rebalancing markets. Against this backdrop, we have kept a sector strategy which favours cyclicality over predictability, income, and/or low volatility. In September, the swift upturn in BRIC vs. G7 LEIs along with OPEC’s oil production freeze should extend the rally in resource cyclicals which we believe is halfway through. Going into the fourth quarter, investors should be cognizant that as the end of the year approaches, performance-chasing activity could compound resource cyclicals’ outperformance.
Energy (OW): OPEC walks the walk and brings forward the rebalancing in global oil markets.
Golds (OW): If the 1993 analogy holds, the uptrend should resume in Q4 despite US$ strength.
Lumbers (MW): The SLA uncertainty leads to an improved reward-to-risk ratio.
Cdn. Airlines (OW): Uptrend resuming on the back of an upcoming increase in EBITDA margins.
Auto & Parts (MW): US banks are tightening lending standards on auto loans, a first in this cycle.
Cdn. Food Retailers (UW): No rebound in retail food inflation. Stay clear!
US Pharmas (UW): Technically breaking down on risk of an upcoming industry margin squeeze.
Cdn. Banks (MW): The spike in housing price inflation raises a yellow flag.
US Semis (OW): and CEMs (OW): Breaking above multi-year relative price resistances. Stay put!