Economic Growth Gaining Momentum

Strengthening global economic growth resulted in stock markets reaching record levels during the second quarter. The Canadian stock market rose 5.7% while the US market (as measured by the S&P 500) increased 4.7%. The S&P 500 in Canadian dollars only increased 1.3% as the US dollar gave back some of the gains from the prior six months The Canadian Bond market returned 2% as bond yields continued to decline.

The stock market has been unusually tranquil. Since the middle of April, the S&P 500 has not had a daily move greater than 1%. This lack of volatility also coincided with a decrease in trading activity. There is concern that the current investor complacency is a precursor to a stock market decline. We do not share these worries as we believe that a stronger economy is positive for stocks.

The US economy appears to have bounced back from a serious stumble in the first quarter. US Auto sales got off to a bumpy start in January and February due to severe winter weather across the Midwest and Northeast. Auto sales picked up in April, surged in May with the strength continuing into June. Low interest rates, a brighter economic outlook and pent up demand due to the US auto fleet’s advanced age are the primary drivers.

The housing market also continues to improve. Existing home sales increased in both April and May. An increase in pending home sales in May is positive for home sales in June and July. Pending home sales is a leading indicator of future housing activity. Both new home starts and housing permits have also been trending up since the end of winter.

Consumer sentiment has been steadily improving. Better employment data has resulted in increasing personal incomes. Employed consumers are feeling increasingly confident that they will keep their jobs as the threat of layoffs has generally receded.

The majority of evidence supports current economic strength continuing through the rest of 2014. A sharp increase in bank loans highlights improved business confidence. A pick up in rail car loading's reflects a strong order book across a broad range of industries. The US ISM manufacturing report for June showed a large jump in new orders. The increased new order rate is confirmation that the US economy continues to improve. This data point could also imply that Durable Goods orders are also improving. Upside in Durable goods orders may signal that companies are finally starting to spend on capital expenditures. An upswing in capital expenditures has been an absent component of this economic recovery.

Since the 2008 recession, companies have under invested in capital expenditures. While capital expenditures can continue to be delayed, they cannot be postponed indefinitely. As CEO's increasingly focuses on growing their businesses, and fear of an economic downturn dissipates, companies will be more likely to invest for growth. Companies have been hesitant to invest their ample cash in their businesses opting instead to spend of it on stock buybacks and dividends.

The Canadian economy’s sluggish growth has resulted in a benign interest rate environment. The Bank of Canada has committed to keeping low interest rates for an extended period of time. We continue to believe that bonds will continue to provide low returns, especially relative to stocks. Bonds are only attractive from the viewpoint that they provide an element of stability to portfolios.

After the stock market's run over the last couple of years we still find stocks attractive. While current Price / Earnings (P/E) multiples are nothing to get excited about, stocks still offer potential returns that are in excess of those offered by bonds. Increasing Price /Earnings multiples have been a large contributor to stock performance over the last few years. While it is possible that multiples will continue their expansion, we put a higher probability that the P/E multiples will not rise from here. Stock price gains will come from an improving economy driving faster than expected corporate revenue and earnings growth. This will translate into lower P/E multiples and higher stock prices to reflect the better prospects for corporate America. While stock markets might continue to rise, not all stocks will benefit to the same magnitude. Call or email us on how you can best position your portfolio to take advantage of an improving economy.

Since our last note at the end of the first quarter, there has been relatively few stock market or economic surprises. The economy continues to improve, interest rates remain low and stocks are more attractive than bonds. We believe that this scenario should prevail for the remainder of 2014.