Third quarter equity market returns were ugly. The S&P 500 declined 6.9% while the S&P / TSX 300
declined 8.6%. Concerns related to global growth was the primary reason for the selloff. China and
emerging market economies slowed resulting in a decline in commodity prices. Corporate earnings
estimates were trimmed mostly due to the strong US dollar. Uncertainty related to timing of the
Federal Open Market Committee's (The Fed) first rate hike in over eight years did not help matters.
While the increased volatility of stock markets is never a pleasant experience, we do not believe that
we are on the cusp of a recession. Pullbacks, such as we are currently experiencing is considered
normal in a bull market, with unpredictable timing.
The US economy appears solid in the face of a dull global economy. While US export are being hurt by
a strong US dollar in the face of weak economies in their trading partners, domestic demand remains
strong and demonstrates ongoing growth. The US consumer remains confident and healthy. US
personal spending rose 0.4% in August compared to the prior month. This was after 0.4% and 0.3 %
increases in July and June. Consumer spending strength is aided by the combination of consistent
growth in hiring rates, falling unemployment rates and rising wages. We are also finally starting to see
consumers spend some of their savings from lower energy prices. Consumer spending is important as it
comprises two thirds of Gross Domestic Product, which is a broad measure of the overall economy.
After a tepid first half, the global economy appears to be gaining momentum due to better growth
advanced first world countries. Nonetheless, China and emerging market economies will continue to
be a drag on global growth. Emerging markets are experiencing a liquidity squeeze related to the
stronger US dollar as it is increasingly more expensive for them to refinance their debt as it comes due.
The Fed did not raise interest rates in September as we expected. Fed Officials decided to wait and
observe the impact on the US economy from financial and economic turmoil abroad. More specifically,
Fed officials are watching for evidence that the US economy is resilient in the face of headwinds of a
stronger dollar, a slowdown in China and volatility in financial markets. Nonetheless, Chairwoman Yellin and Fed Governors Dudley and Williams
have recently stated that they still expect the
central bank to raise interest rates by the end of
2015. Global monetary policies are diverging as
Europe and Japan will continue with their
quantitative easing programs, whereas the US is
expected to embark on a rate tightening cycle.
The US Stock market appears to be fairly valued,
with the forward price earnings ratio being close
to its long term average. Earnings estimates for
2015 have declined over the last 6 months,
primarily due to the strong US dollar and its impact
on foreign earnings of US multinationals. The US
dollar has recently stabilized relative to most
foreign currencies. As forward estimates already
account for the strong US dollar, a stable US dollar
would result in earnings estimates being realistic
and achievable. 2016 earnings estimates are
currently forecasted to rise mid – high single digits,
which is a good indication of what can be expect in
the way of stock gains over the next twelve
months.
The US Stock market appears to be fairly valued,
with the forward price earnings ratio being close
to its long term average. Earnings estimates for
2015 have declined over the last 6 months,
primarily due to the strong US dollar and its impact
on foreign earnings of US multinationals. The US
dollar has recently stabilized relative to most
foreign currencies. As forward estimates already
account for the strong US dollar, a stable US dollar
would result in earnings estimates being realistic
and achievable. 2016 earnings estimates are
currently forecasted to rise mid – high single digits,
which is a good indication of what can be expect in
the way of stock gains over the next twelve
months.
The US business cycle is maturing, in part due to
its longevity but also due to many cyclical
indicators being near or above past peaks. US
profit margins are near peak levels and have
been soft recently due to rising wages and a
stronger US dollar. While these negatives need
to be monitored for further signs of
deterioration they do not sufficiently concern us
to modify our positions. This recovery has been
more muted than prior cycles, permitting it to
continue longer than has been the historical
norm. Recent flattening of the US dollar would
allow margins to at least stabilize at current
levels.
We do not believe that stocks are entering a
bear market. With stocks being extremely
oversold, the market is set to bounce off the
lows resulting in a strong quarter for stocks.
The fourth quarter has historically been the
strongest quarter for equities. Summer sell offs
tend to reverse, and we see no reason why this
would not be the case this time. We will revisit
stock positions towards the end of the quarter
with an eye to paring overweight equity
positions.
During the first half of 2015, Canada experienced a
short, shallow recession, mostly due to lower
energy prices. The economies of the provinces
outside of the energy patch were not impacted by
this recession. Canada exited the recession with
the GDP rising in both June and July. After two
interest rate cuts, it is unlikely that the Bank of
Canada will continue cutting rates due to the
firming of the economy. US GDP growth is
forecasted to be a full percentage point higher
than Canadian GDP growth for both 2015 and
2016. The Canadian dollar experienced a
significant decline relative to the US dollar due to
the weak Canadian economy and the decline in
the Bank of Canada benchmark rate. The
depreciated dollar makes Canadian goods and
services more competitive and provides a lift to
Canadian exporters. This is good for the
manufacturing sector and counter balances some
of the weakness in the energy and commodity
sectors.
The possibility of oil prices bottoming and the
Bank of Canada keeping interest rates steady
should limit the future decline of the Canadian
dollar. If oil prices increase in 2016, this would be
considered a major positive for the Canadian
dollar and stock market.
The Canadian stock market has significantly
underperformed the US market over the last year
due to both weak commodity prices and a weak
economy. While it is not surprising that anything
related to the energy sector suffered significant
losses, it is somewhat surprising that the financial
sector has also taken a hit. This selling pressure
is based on fears of deteriorating credit quality
in both energy and real estate related loans.
Both the Canadian currency and stock market
are correlated to the price of oil and the health
of emerging markets. Weak commodity prices
are largely reflected in current stock prices and
currency exchange rates. A sign of stock
bottoms occurs when the bear case can be well
articulated, as is the case now. With the
majority of negative news priced into financial
market and oil prices trying to find a bottom, we
believe are nearing an inflection point with
respect to a bottom in Canadian stocks and a
top in the US dollar. In the portfolios we
manage, we are evaluating when would be the
appropriate time to lift Canadian stock weights.
The Canadian bond market was flat for the last
three months. The Bank of Canada did not
lower rates in September as widely anticipated
due to stabilization in the Canadian economy.
While growth is not forecast to rise above 2%
over the next year, it is still forecasted to grow.
We expect the Bank of Canada rate to remain at
current levels, but do envision a rise in longer
term (5 - 10 years) rates. This increase in longer
term rates will continue to pressure the bond
market. Investors should expect low single digit
bond returns for the foreseeable future.
We continue to prefer equities over bonds and
US over Canadian stocks. Canadian stock
market results from the past year were
discouraging (down 11% over last twelve months). Our clients were not significantly
impacted as we mostly avoided these markets.
We are warming up to the idea of increasing our
Canadian stock weights in the coming year. We
feel that some Canadian stocks were unfairly
“punished” and that we are nearing an inflection
point for the Canadian dollar relative to the US
dollar. We continue to believe that US stocks will
perform better than Canadian stocks over the long
term while also providing diversification
opportunities that are not available in the
Canadian market. We see bonds as an asset class
that will provide stability to portfolios despite their
somewhat mediocre returns. With the Fed on the
cusp of raising interest rates, we expect the stock
market to be increasingly volatile with more
frequent corrections. Typically, we have not been
aggressive in paring positions that have grown
significantly as a percentage of the overall
portfolio. Given the increasing volatility in stock
prices, we intend to pro-actively take profits and
keep positions within their targeted range.
This has been one of our more lengthy quarterly
news reports, a reflection of the increasing
complexity of global market interactions. When
beginning a tightening cycle, it becomes even
more important to trust your financial advisor to
be in tune with your individual client risk profile.
We, at Condor Assess Management, pride
ourselves in being available for consultation and
advice at any time.
Thursday, October 15, 2015
Wednesday, July 22, 2015
The Pause That Refreshes
With second quarter US economic data validating our thesis that first quarter weakness was largely
transitory, it appears increasingly likely that the Fed will raise interest rates sometime in 2015. While
the resumption of economic growth is positive for stocks, it will not necessarily bode well for the bond
market. The Canadian bond market returned over 4% in the first quarter as investors questioned the
sustainability and pace of economic growth. With more recent data demonstrating economic growth,
rising interest rates resulted in the bond market giving back almost half of the first quarter's gains
resulting in a -1.7% return for the bond market.
For a change of pace, most of the action was in the bond market during the second quarter as government yields increased sharply. Ten year German Bund Yields rose from a low of 0.1% to over 1.0% before settling in around 0.76%. The sharp movement in German bonds was related to unsettling remarks from the chair of the European Central Bank, Mario Draghi in combination with bond yields being unusually low due to deflationary concerns. With Europe leaning more to an economic recovery, deflationary fears eventually dissipated resulting in a rise in interest rates. This rise in German bond yields was the primary catalyst for an upswing in global government bond yields.
The Greek debt crisis pushed stock markets into the red at the end of the second quarter, despite trading flat for the majority of the quarter. Notwithstanding fears of a Greek default and exit from the European Economic Union, the quarter was relatively quiet with most stocks trading within a narrow band. The S&P 500 (US $) was flattish (-0.2%) while declining 1.9% in CDN dollars. The Canadian markets (as measured by the S&P / TSX composite) declined by 2.3%.
The end of the brutally cold winter season contributed to a more positive GDP in Q2. Retail sales accelerated and consumer spending growth is tracking to increase 2.3% in Q2 (final numbers have not yet reported). We are also seeing rising auto sales and the continued growth in housing starts. Consumer balance sheets are also in great shape. Household liabilities / assets are at fifteen year lows of around 21% which compares to greater than 30% in 2007. Recent employment data is also coming in strong with employment growth of 2.2% and year over year payroll income growth of 4.3%. This has resulted in the savings rate increasing by 1% over the last eight months. Also contributing to the higher savings rate is lower oil prices putting more money in consumers' wallets.
Investors have taken more of a wait and see attitude with respect to putting cash to work in the stock markets. To use a poker analogy, they are "checking" for more information before making large bets on the stock market. There are a number of wild cards and investors are searching for clues as to how they settle out. A number of geo-political situations (Russia and the Ukraine, ISIS) are periodically diverting investor's attention away from corporate earnings, which is the primary long term driver of stock prices. Greece's perennial debt restructuring drama remains a concern, with fears of a Greek debt default and its impact on the Euro. Company valuations are also a little higher than historical averages, reducing the margin of safety. Global growth remains tepid. The strong US dollar is also acting as a headwind for US company revenue and earnings growth. We continue to believe that these issues are unlikely to derail the economic expansion or the bull market for stocks.
The US stock market has had some big gains over the last few years, and it would be prudent to expect some sort of pause before resuming its upward trajectory. Absent an imminent recession (which we do not envision), we don't foresee a large market correction. For the stock market to begin its next upward swing, there will need to be growth in corporate revenue and earnings. Although earnings continue to grow, they do so at a slower pace than we originally forecasted six months ago. Stocks moving sideways coupled with a little more earnings growth will result in valuations trending down to something that is closer to the long term average. We feel that we are currently experiencing nothing more than a pause in a bull market. Longer term we continue to prefer stocks over bonds. With a stronger US economy, and the Fed poised to increase interest rates, the recent rise in US interest rates is unlikely to reverse. We expect US interest rates to continue to creep up resulting in low single digit bond returns. Canadian rates are likely to stay flat, as the Canadian economy is not as robust as the US economy.
Contact us to ensure that you are properly positioned to navigate these potentially murky markets.
For a change of pace, most of the action was in the bond market during the second quarter as government yields increased sharply. Ten year German Bund Yields rose from a low of 0.1% to over 1.0% before settling in around 0.76%. The sharp movement in German bonds was related to unsettling remarks from the chair of the European Central Bank, Mario Draghi in combination with bond yields being unusually low due to deflationary concerns. With Europe leaning more to an economic recovery, deflationary fears eventually dissipated resulting in a rise in interest rates. This rise in German bond yields was the primary catalyst for an upswing in global government bond yields.
The Greek debt crisis pushed stock markets into the red at the end of the second quarter, despite trading flat for the majority of the quarter. Notwithstanding fears of a Greek default and exit from the European Economic Union, the quarter was relatively quiet with most stocks trading within a narrow band. The S&P 500 (US $) was flattish (-0.2%) while declining 1.9% in CDN dollars. The Canadian markets (as measured by the S&P / TSX composite) declined by 2.3%.
The end of the brutally cold winter season contributed to a more positive GDP in Q2. Retail sales accelerated and consumer spending growth is tracking to increase 2.3% in Q2 (final numbers have not yet reported). We are also seeing rising auto sales and the continued growth in housing starts. Consumer balance sheets are also in great shape. Household liabilities / assets are at fifteen year lows of around 21% which compares to greater than 30% in 2007. Recent employment data is also coming in strong with employment growth of 2.2% and year over year payroll income growth of 4.3%. This has resulted in the savings rate increasing by 1% over the last eight months. Also contributing to the higher savings rate is lower oil prices putting more money in consumers' wallets.
Investors have taken more of a wait and see attitude with respect to putting cash to work in the stock markets. To use a poker analogy, they are "checking" for more information before making large bets on the stock market. There are a number of wild cards and investors are searching for clues as to how they settle out. A number of geo-political situations (Russia and the Ukraine, ISIS) are periodically diverting investor's attention away from corporate earnings, which is the primary long term driver of stock prices. Greece's perennial debt restructuring drama remains a concern, with fears of a Greek debt default and its impact on the Euro. Company valuations are also a little higher than historical averages, reducing the margin of safety. Global growth remains tepid. The strong US dollar is also acting as a headwind for US company revenue and earnings growth. We continue to believe that these issues are unlikely to derail the economic expansion or the bull market for stocks.
The US stock market has had some big gains over the last few years, and it would be prudent to expect some sort of pause before resuming its upward trajectory. Absent an imminent recession (which we do not envision), we don't foresee a large market correction. For the stock market to begin its next upward swing, there will need to be growth in corporate revenue and earnings. Although earnings continue to grow, they do so at a slower pace than we originally forecasted six months ago. Stocks moving sideways coupled with a little more earnings growth will result in valuations trending down to something that is closer to the long term average. We feel that we are currently experiencing nothing more than a pause in a bull market. Longer term we continue to prefer stocks over bonds. With a stronger US economy, and the Fed poised to increase interest rates, the recent rise in US interest rates is unlikely to reverse. We expect US interest rates to continue to creep up resulting in low single digit bond returns. Canadian rates are likely to stay flat, as the Canadian economy is not as robust as the US economy.
Contact us to ensure that you are properly positioned to navigate these potentially murky markets.
Thursday, April 23, 2015
First Quarter Review and Outlook
Our clients have done well this quarter. The ongoing strength of the US dollar was the main story of the first quarter. The US Dollar gained 9.3% versus the Canadian Dollar and 12.7% against the Euro. Condor's clients benefited from the stronger US Dollar as the majority of equities held by our clients are in US stocks. Diverging policies from central bankers with respect to interest rates was the primary reason for the rising US dollar. The US Fed Reserve Bank is signaling that they are poised to begin an interest rate tightening cycle due to better economic data. Europe is entering a period of lower rates as the European Central Bank is starting a quantitative easing program. Here in Canada, The Bank of Canada cut interest rates due to slackening economic growth. All things being equal, higher interest rates and a stronger economy tend to attract investments resulting in higher exchange rates.
Although our clients saw their portfolio values increase, stocks were relatively flat for the quarter, not withstanding their trading with increasing volatility. The S&P 500 increased fractionally (+0.4%), while the Canadian market (S&P / TSX) was up 1.8% reversing some of the decline from the previous six months. The Canadian bond market returned 4.2% as it benefited from the surprise interest rate cut by the Bank of Canada.
US economic growth was positive during the first quarter, but was not as robust as the prior three quarters. Economic activity was impacted by the West Coast port strike and unusually cold weather. This will translate into earnings growth being a little slower than previously forecast. Companies with big international exposure will also see earnings impacted by a stronger dollar which will hurt both sales and margins.
Lower energy prices detracted from the aggregate S&P 500 earnings number, as energy companies realized lower revenues and profits. On the other hand, companies with significant energy input costs have yet to see the benefit of lower commodity prices. Companies that are net energy users, typically hedge oil and gas costs six to twelve months out. These companies will benefit from lower energy prices in the second half of the year as the hedges roll off. We recently saw the first example of this when Carnival Cruise Lines reported better than expected earnings, primarily related to lower energy costs. For 2015, this will result in the S&P 500 earnings recovering some of the earnings lost from the energy producing companies.
Equity markets remain fairly valued, being neither cheap nor expensive. Markets that are fairly valued, with average economic growth (2.0% - 3.5%) should see stock prices increase close to the long term average of 7 - 8%. S&P 500 returns were flat during the quarter, but this follows positive returns in every quarter of 2014. The S&P 500 appears to be consolidating last year's gain resulting in a churning type of market. The volatility in the first quarter is probably a good indication of what to expect for the remainder of the year.
With the Fed on the cusp of its first interest rate hike in many years, we would expect that stock volatility will increase. While there has been significant analysis of when the Fed will institute the first rate hike, there has been little discussion as to the type or timeline for subsequent rate hikes. We believe that interest rate hikes will be at a measured pace (0.25% per rate hike) and continue at a slow and gradual pace. We anticipate the Fed's future action will be data dependent. If the economy continues to experience strong growth, rates will continue to increase. If growth lags, rate increases will be put on hold. We do not believe that rate hikes will cause major problems for the economy or the financial markets as interest rates are currently near zero. A cumulative rate increase of 1.0% will still leave interest rates below what is considered to be neutral and will remain economically stimulative.
The Bank of Canada lowered the overnight lending rate in January by 0.25% due to a sluggish economic outlook related to lower oil prices. The rate cut took everyone (including us) by surprise, resulting in strong bond returns in the first quarter. Our current thoughts are that the Bank of Canada is unlikely to change interest rates in the short-term. With the current low level of interest rates, bond returns will remain in the low single digit range.
US dollar strength should persist, albeit not to the same degree as the last four months. US GDP growth is stronger than Canadian GDP growth and this situation should continue through the remainder of 2015. The US economy is benefiting from accelerating job growth, stronger US auto production and increased housing activity. Canada on the other hand is facing economic challenges from a combination of layoffs associated with lower oil prices and a peaking housing market. This potentially leads to higher interest rates in the US with the Bank of Canada having more of a neutral bias on rates.
Depressed oil prices are also impacting the Canadian dollar US dollar exchange rate. Lower oil prices result in less (US $) revenues for energy companies. As Canadian energy producers convert less US dollar revenues into Canadian dollars (to cover their costs), there is less demand for Canadian dollars. The Canadian dollar has been viewed by some financial investors, as a “petro currency” resulting in the dollar moving in tandem with oil prices. Persistent oil price weakness has translated into persistent Canadian dollar weakness. If the price of oil rebounds significantly, there would be a reversal of the recent Canadian dollar weakness. Our ability to predict oil production is limited due to the uncertainly of global conflicts and of OPEC oil quotas.
We continue to believe that stocks are the most attractive asset class, although we expect stock volatility to be higher and stock returns to be lower as compared to the last few years. While stock price variability will increase, we currently do not envision a stock market decline of greater than 10% as economic growth is still positive and stock valuations are not expensive. Bonds will continue to yield positive returns, but in a low interest rate environment, returns are unlikely to be as robust as equities.
Although our clients saw their portfolio values increase, stocks were relatively flat for the quarter, not withstanding their trading with increasing volatility. The S&P 500 increased fractionally (+0.4%), while the Canadian market (S&P / TSX) was up 1.8% reversing some of the decline from the previous six months. The Canadian bond market returned 4.2% as it benefited from the surprise interest rate cut by the Bank of Canada.
US economic growth was positive during the first quarter, but was not as robust as the prior three quarters. Economic activity was impacted by the West Coast port strike and unusually cold weather. This will translate into earnings growth being a little slower than previously forecast. Companies with big international exposure will also see earnings impacted by a stronger dollar which will hurt both sales and margins.
Lower energy prices detracted from the aggregate S&P 500 earnings number, as energy companies realized lower revenues and profits. On the other hand, companies with significant energy input costs have yet to see the benefit of lower commodity prices. Companies that are net energy users, typically hedge oil and gas costs six to twelve months out. These companies will benefit from lower energy prices in the second half of the year as the hedges roll off. We recently saw the first example of this when Carnival Cruise Lines reported better than expected earnings, primarily related to lower energy costs. For 2015, this will result in the S&P 500 earnings recovering some of the earnings lost from the energy producing companies.
Equity markets remain fairly valued, being neither cheap nor expensive. Markets that are fairly valued, with average economic growth (2.0% - 3.5%) should see stock prices increase close to the long term average of 7 - 8%. S&P 500 returns were flat during the quarter, but this follows positive returns in every quarter of 2014. The S&P 500 appears to be consolidating last year's gain resulting in a churning type of market. The volatility in the first quarter is probably a good indication of what to expect for the remainder of the year.
With the Fed on the cusp of its first interest rate hike in many years, we would expect that stock volatility will increase. While there has been significant analysis of when the Fed will institute the first rate hike, there has been little discussion as to the type or timeline for subsequent rate hikes. We believe that interest rate hikes will be at a measured pace (0.25% per rate hike) and continue at a slow and gradual pace. We anticipate the Fed's future action will be data dependent. If the economy continues to experience strong growth, rates will continue to increase. If growth lags, rate increases will be put on hold. We do not believe that rate hikes will cause major problems for the economy or the financial markets as interest rates are currently near zero. A cumulative rate increase of 1.0% will still leave interest rates below what is considered to be neutral and will remain economically stimulative.
The Bank of Canada lowered the overnight lending rate in January by 0.25% due to a sluggish economic outlook related to lower oil prices. The rate cut took everyone (including us) by surprise, resulting in strong bond returns in the first quarter. Our current thoughts are that the Bank of Canada is unlikely to change interest rates in the short-term. With the current low level of interest rates, bond returns will remain in the low single digit range.
US dollar strength should persist, albeit not to the same degree as the last four months. US GDP growth is stronger than Canadian GDP growth and this situation should continue through the remainder of 2015. The US economy is benefiting from accelerating job growth, stronger US auto production and increased housing activity. Canada on the other hand is facing economic challenges from a combination of layoffs associated with lower oil prices and a peaking housing market. This potentially leads to higher interest rates in the US with the Bank of Canada having more of a neutral bias on rates.
Depressed oil prices are also impacting the Canadian dollar US dollar exchange rate. Lower oil prices result in less (US $) revenues for energy companies. As Canadian energy producers convert less US dollar revenues into Canadian dollars (to cover their costs), there is less demand for Canadian dollars. The Canadian dollar has been viewed by some financial investors, as a “petro currency” resulting in the dollar moving in tandem with oil prices. Persistent oil price weakness has translated into persistent Canadian dollar weakness. If the price of oil rebounds significantly, there would be a reversal of the recent Canadian dollar weakness. Our ability to predict oil production is limited due to the uncertainly of global conflicts and of OPEC oil quotas.
We continue to believe that stocks are the most attractive asset class, although we expect stock volatility to be higher and stock returns to be lower as compared to the last few years. While stock price variability will increase, we currently do not envision a stock market decline of greater than 10% as economic growth is still positive and stock valuations are not expensive. Bonds will continue to yield positive returns, but in a low interest rate environment, returns are unlikely to be as robust as equities.
Thursday, January 15, 2015
Q4 2014 Commentary
2014 was a good year for Condor Asset management's clients with returns that were superior to both
the Canadian stock and bond markets. Condor's client’s portfolios were well positioned to benefit
from US dollar and US stock market strength.
We anticipate that 2015 will be another positive year for both stocks and the US dollar. US GDP growth, the driver of global macro growth, is forecasted to be approximately 3.0%. In contrast, the current growth prediction for Canada is an expansion of 2.0%, and for Japan and the Euro zone to grow by 1%. Positive global growth combined with low inflation sets a positive tone for global stock markets, but to a lesser degree for the bond markets. Economic expansion will be reinforced by the recent drop in oil prices.
Oil prices declined from a high of $107 in mid 2014 to below $55 per barrel by year end. Supply has outpaced demand for a considerable time however the focus has been on the ability to withstand supply interruptions related to countries experiencing political turmoil. Towards the end of the year, some of these concerns dissipated as additional supplies came on stream. Libya increased production from 250,000 barrels / day in June to 900,000 barrels / day by October. Iraq also shipped more crude and Iran has benefitted from a partial lifting of the oil embargo. The biggest sustained contributor to the increase in 2014 supply has been the relentless increase in North American production due to the shale revolution. Demand this year has also not been as robust as originally forecast. All this is to say that supply turned out better than anticipated while demand was less than expected.
In response, there has been an orderly downslide in the price of crude beginning over the summer months. A November OPEC meeting which failed to resolve the excess supply situation, precipitated a significant decline in oil prices in a relatively short period of time. As OPEC’s swing producer, Saudi Arabia has the biggest influence over supply matching demand. They chose not to cut their production levels to accommodate other members who were over shipping. A lack of consensus on how to curtail supply by OPEC members, Russia and Mexico left supply at levels that were greater than demand. Increasing demand or decreasing supply is the only way for a market to return to equilibrium. While it is difficult to predict exactly how this plays out, it is unlikely there will be a quick resolution. Demand growth will continue to move upwards, but in a slow and orderly fashion. Current low oil prices may result in consumption increasing slightly faster than expected, however demand growth tends to be a gradual process.
Energy companies have begun to cut back their exploration budgets as new development is deemed uneconomic at current prices. This will not result in an immediate decrease in production, but will ultimately slow the pace of supply growth. Projects currently underway will continue as the majority of costs associated with these projects are front end loaded. Alternatively, the undertaking of new projects is more likely to be put on hold, given the current market supply glut.
While lower oil prices might not be good for firms involved in energy extraction, it is positive for consumers, global growth and inflation. Net oil imports in the US, Japan and Europe represent 1.2%, 3.0% and 2.0% of respective GDP. Consumers in these countries will be the prime beneficiaries of lower oil prices. Declining energy costs will be additive to GDP growth in these countries by anywhere from 0.4% to 0.8%. Estimates are that the average American family will save $400 to $800 this year, a portion of which will translate into additional consumer spending.
Lower oil prices will also result in lower inflation and inflation expectations allowing most central bankers to keep interest rates low. The US will be the exception to this stable interest rate world. As US economic growth picks up, it is anticipated that the Fed will raise interest rates sometime during 2015. The added benefit to economic growth and consumer confidence from lower oil prices could lead the Fed to act earlier than previously thought. Faster economic growth in the US versus the rest of the world combined with higher US interest rates should result in continued US dollar strength.
We anticipate a good year for the stock market. We do not foresee a global recession in the short term. As the stock market is neither cheap nor expensive (Charts 2 & 3), we anticipate US earnings gains of 8% translating into an 8 - 10% gain for the US stock market. A plausible scenario of faster than predicted GDP and earnings growth would translate into US stocks rising more than 8-12%. The US stock market should perform better than the Canadian stock market as Canadian earnings will not grow as fast as US earnings. The Canadian stock market is over exposed to the energy sector (Chart 1) which will act as a headwind for income growth.
CHART 1: Energy as a % of the S&P TSX Index
Source: BMO, HIS Global Insights
CHART 2: P/E for NEXT TWELVE MONTHS
Source: J.P. Morgan and Bloomberg
CHART 3: PRICE / BOOK Source:
J.P. Morgan and Bloomberg
US family debt is at its lowest level in 10 years. Total US household debt, when measured as a share of disposable income has fallen from 135% in 2007 to 108% in September 2014. This compares to a current reading for Canadian household debt of 167%, which is the highest in the developed world. Healthier US consumer balance sheets, combined with cheaper gasoline could provide a boast to consumer spending. As a reminder, the US consumer accounts for 2/3 of the US economy. Due to the high level of debt in Canada, consumers are not as well positioned to increase spending.
As previously stated, interest rates are forecasted to rise in the US. This will create headwinds for bond returns as rising interest rates are negative for bond prices. The Canadian bond market will perform a little better than its US counterpart, as we are not forecasting a rate increase from the Bank of Canada in 2015. Assuming relatively flat interest rates, Canadian bond returns will still be in low single digits. CHART 3: PRICE / BOOK Source: J.P. Morgan and Bloomberg
While there is a perception that rising interest rates are negative for the equity markets we do not believe it is justified based on the current scenario. History suggests that initial rate hikes do not necessarily derail equity markets. US interest rates are rising due to a strengthening US economy. US interest rates are only forecast to increase 0.5% - 1.0% next year, which should not significantly impact the economy or the stock market. We are aware that rising stock volatility will accompany the anticipated Federal Reserve rate increase. We witnessed this towards the end of 2014 with the end of quantitative easing. The stock market did rise, but the market had an almost 10% correction before rebounding. We used this correction as opportunities to put cash to work.
While we believe that 2015 will provide investors with positive returns, it does not mean that investing in the financial markets is without risk. Although the past year is considered a “bull market” it was not accompanied by typical investor euphoria. This particular bull market almost has a stealthy characteristic to it. It appears as if the only time that the market is widely discussed in the popular media is when the stock market declines. On the other hand, the majority of Wall Street Strategists have forecasts with stocks gaining 8 – 12% during 2015. The assumptions underlying these forecasts are not overly aggressive.
Another macro risk is the moderation in Chinese economic growth. China is experiencing a reduction in infrastructure spending, a primary driver of Chinese GDP gains over the last two decades. This reduction is presumably a long-term change, but current investment levels are reasonable for the foreseeable future. We are also monitoring the Chinese housing industry for signs of a bubble, but currently do not anticipate that it will have a meaningful negative impact on the economy.
With oil around $50 per barrel, a number of undercapitalized, over levered companies will go bankrupt. We have already started to see this play out as some of the smaller exploration companies have cut dividends and / or slashed exploration budgets. Companies going into chapter 11 will ultimately result in their assets landing in stronger hands as they are bought out of bankruptcy by better capitalized firms. While headlines related to these types of events are never pretty, it is nothing more than the market working to sort itself out, albeit in a somewhat disorderly fashion.
Political instability resulting from lower oil prices are a more concerning risk that is challenging to model or predict. The consequences could be regime change, war, revolt or a myriad of other events. For example, a country such as Venezuela where the majority of government revenues comes from oil revenues will find their spending constrained. Does that translate in their selling less discounted oil to Cuba and China? Does this weakening of finances increase the likelihood of regime change in Venezuela? If they decide to ship less oil to Cuba, what are the implications for Cuba and the leadership there? Did lower oil prices have an influence on the normalization of relations between the US and Cuba? How do governments respond to increasingly unbalanced budgets? Is there anything to stop Russia from invading Azerbaijan or Kazakhstan? What are the implications from the decline in the Ruble and the currencies of other oil producing states? As can be seen from preceding list of potential political events there is a whole host of outcomes not all of them good or easily predictable. We will be closely following the geopolitical climate in 2015 as it relates to global markets.
Global GDP will grow in excess of 3%. The decline in energy prices will be additive to consumer spending growth and will provide a tailwind to further GDP growth. Inflation will not be a huge factor, and again will be aided by the drop in energy prices. Global interest rates will largely remain flat, except for in the US where economic growth is accelerating. Stock picking and being in the right sectors (and avoiding the wrong sectors) will be a critical component to navigating the current choppy investment climate. We continue to believe that fundamentally sound investments will continue to be beneficial for our clients. Feel free to contact us to discuss if your investments are properly positioned.
We anticipate that 2015 will be another positive year for both stocks and the US dollar. US GDP growth, the driver of global macro growth, is forecasted to be approximately 3.0%. In contrast, the current growth prediction for Canada is an expansion of 2.0%, and for Japan and the Euro zone to grow by 1%. Positive global growth combined with low inflation sets a positive tone for global stock markets, but to a lesser degree for the bond markets. Economic expansion will be reinforced by the recent drop in oil prices.
Oil prices declined from a high of $107 in mid 2014 to below $55 per barrel by year end. Supply has outpaced demand for a considerable time however the focus has been on the ability to withstand supply interruptions related to countries experiencing political turmoil. Towards the end of the year, some of these concerns dissipated as additional supplies came on stream. Libya increased production from 250,000 barrels / day in June to 900,000 barrels / day by October. Iraq also shipped more crude and Iran has benefitted from a partial lifting of the oil embargo. The biggest sustained contributor to the increase in 2014 supply has been the relentless increase in North American production due to the shale revolution. Demand this year has also not been as robust as originally forecast. All this is to say that supply turned out better than anticipated while demand was less than expected.
In response, there has been an orderly downslide in the price of crude beginning over the summer months. A November OPEC meeting which failed to resolve the excess supply situation, precipitated a significant decline in oil prices in a relatively short period of time. As OPEC’s swing producer, Saudi Arabia has the biggest influence over supply matching demand. They chose not to cut their production levels to accommodate other members who were over shipping. A lack of consensus on how to curtail supply by OPEC members, Russia and Mexico left supply at levels that were greater than demand. Increasing demand or decreasing supply is the only way for a market to return to equilibrium. While it is difficult to predict exactly how this plays out, it is unlikely there will be a quick resolution. Demand growth will continue to move upwards, but in a slow and orderly fashion. Current low oil prices may result in consumption increasing slightly faster than expected, however demand growth tends to be a gradual process.
Energy companies have begun to cut back their exploration budgets as new development is deemed uneconomic at current prices. This will not result in an immediate decrease in production, but will ultimately slow the pace of supply growth. Projects currently underway will continue as the majority of costs associated with these projects are front end loaded. Alternatively, the undertaking of new projects is more likely to be put on hold, given the current market supply glut.
While lower oil prices might not be good for firms involved in energy extraction, it is positive for consumers, global growth and inflation. Net oil imports in the US, Japan and Europe represent 1.2%, 3.0% and 2.0% of respective GDP. Consumers in these countries will be the prime beneficiaries of lower oil prices. Declining energy costs will be additive to GDP growth in these countries by anywhere from 0.4% to 0.8%. Estimates are that the average American family will save $400 to $800 this year, a portion of which will translate into additional consumer spending.
Lower oil prices will also result in lower inflation and inflation expectations allowing most central bankers to keep interest rates low. The US will be the exception to this stable interest rate world. As US economic growth picks up, it is anticipated that the Fed will raise interest rates sometime during 2015. The added benefit to economic growth and consumer confidence from lower oil prices could lead the Fed to act earlier than previously thought. Faster economic growth in the US versus the rest of the world combined with higher US interest rates should result in continued US dollar strength.
We anticipate a good year for the stock market. We do not foresee a global recession in the short term. As the stock market is neither cheap nor expensive (Charts 2 & 3), we anticipate US earnings gains of 8% translating into an 8 - 10% gain for the US stock market. A plausible scenario of faster than predicted GDP and earnings growth would translate into US stocks rising more than 8-12%. The US stock market should perform better than the Canadian stock market as Canadian earnings will not grow as fast as US earnings. The Canadian stock market is over exposed to the energy sector (Chart 1) which will act as a headwind for income growth.
CHART 1: Energy as a % of the S&P TSX Index
CHART 2: P/E for NEXT TWELVE MONTHS
CHART 3: PRICE / BOOK Source:
US family debt is at its lowest level in 10 years. Total US household debt, when measured as a share of disposable income has fallen from 135% in 2007 to 108% in September 2014. This compares to a current reading for Canadian household debt of 167%, which is the highest in the developed world. Healthier US consumer balance sheets, combined with cheaper gasoline could provide a boast to consumer spending. As a reminder, the US consumer accounts for 2/3 of the US economy. Due to the high level of debt in Canada, consumers are not as well positioned to increase spending.
As previously stated, interest rates are forecasted to rise in the US. This will create headwinds for bond returns as rising interest rates are negative for bond prices. The Canadian bond market will perform a little better than its US counterpart, as we are not forecasting a rate increase from the Bank of Canada in 2015. Assuming relatively flat interest rates, Canadian bond returns will still be in low single digits. CHART 3: PRICE / BOOK Source: J.P. Morgan and Bloomberg
While there is a perception that rising interest rates are negative for the equity markets we do not believe it is justified based on the current scenario. History suggests that initial rate hikes do not necessarily derail equity markets. US interest rates are rising due to a strengthening US economy. US interest rates are only forecast to increase 0.5% - 1.0% next year, which should not significantly impact the economy or the stock market. We are aware that rising stock volatility will accompany the anticipated Federal Reserve rate increase. We witnessed this towards the end of 2014 with the end of quantitative easing. The stock market did rise, but the market had an almost 10% correction before rebounding. We used this correction as opportunities to put cash to work.
While we believe that 2015 will provide investors with positive returns, it does not mean that investing in the financial markets is without risk. Although the past year is considered a “bull market” it was not accompanied by typical investor euphoria. This particular bull market almost has a stealthy characteristic to it. It appears as if the only time that the market is widely discussed in the popular media is when the stock market declines. On the other hand, the majority of Wall Street Strategists have forecasts with stocks gaining 8 – 12% during 2015. The assumptions underlying these forecasts are not overly aggressive.
Another macro risk is the moderation in Chinese economic growth. China is experiencing a reduction in infrastructure spending, a primary driver of Chinese GDP gains over the last two decades. This reduction is presumably a long-term change, but current investment levels are reasonable for the foreseeable future. We are also monitoring the Chinese housing industry for signs of a bubble, but currently do not anticipate that it will have a meaningful negative impact on the economy.
With oil around $50 per barrel, a number of undercapitalized, over levered companies will go bankrupt. We have already started to see this play out as some of the smaller exploration companies have cut dividends and / or slashed exploration budgets. Companies going into chapter 11 will ultimately result in their assets landing in stronger hands as they are bought out of bankruptcy by better capitalized firms. While headlines related to these types of events are never pretty, it is nothing more than the market working to sort itself out, albeit in a somewhat disorderly fashion.
Political instability resulting from lower oil prices are a more concerning risk that is challenging to model or predict. The consequences could be regime change, war, revolt or a myriad of other events. For example, a country such as Venezuela where the majority of government revenues comes from oil revenues will find their spending constrained. Does that translate in their selling less discounted oil to Cuba and China? Does this weakening of finances increase the likelihood of regime change in Venezuela? If they decide to ship less oil to Cuba, what are the implications for Cuba and the leadership there? Did lower oil prices have an influence on the normalization of relations between the US and Cuba? How do governments respond to increasingly unbalanced budgets? Is there anything to stop Russia from invading Azerbaijan or Kazakhstan? What are the implications from the decline in the Ruble and the currencies of other oil producing states? As can be seen from preceding list of potential political events there is a whole host of outcomes not all of them good or easily predictable. We will be closely following the geopolitical climate in 2015 as it relates to global markets.
Global GDP will grow in excess of 3%. The decline in energy prices will be additive to consumer spending growth and will provide a tailwind to further GDP growth. Inflation will not be a huge factor, and again will be aided by the drop in energy prices. Global interest rates will largely remain flat, except for in the US where economic growth is accelerating. Stock picking and being in the right sectors (and avoiding the wrong sectors) will be a critical component to navigating the current choppy investment climate. We continue to believe that fundamentally sound investments will continue to be beneficial for our clients. Feel free to contact us to discuss if your investments are properly positioned.
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