Highlights This Month
- THE S&P KEEPS RISING, BUT U.S. INVESTORS ARE SELLING.
- U.S DOLLAR BULL MARKET CREATES TRICKY ENVIRONMENT TO PREDICT CRUDE OIL PRICES.
- THE EUROZONE HAS STABILIZED, BUT CAN GROWTH BE SUSTAINED?
- CHINA’S SLOWING ECONOMY IS LEADING TO A BALANCED ECONOMY.
- SHOULD INVESTORS INVEST IN CHINA?
- WHAT TREND REVERSALS AND CORRECTIONS CAN WE EXPECT?
- A WEAK Q1 FOR THE U.S. ISN’T AN INDICATOR FOR THE REST OF THE YEAR.
- DESPITE POCKETING SAVINGS AT THE PUMP, CONSUMERS SIT ON THEIR WALLETS.
- REASONS WHY THE U.S. HOUSING MARKET IS SHOWING SIGNS OF LIFE.
- ARE LOWER INTEREST RATES HERE TO STAY? CONSIDER THESE EARLY INDICATORS.
- CANADA LOST JOBS, BUT THE UNEMPLOYMENT RATE REMAINED UNCHANGED.
- THERE’S A TWO-SPEED MARKET FOR REAL ESTATE IN CANADA.
- THE IMPACT OF THE RETREATING ENERGY SECTOR TO EASE THROUGH THE YEAR.
The NWM Portfolio
Canadian equities were stronger in April with the S&P/TSX up 2.4%, while NWM Canadian Equity Income (formerly Strategic Income Fund) gained 1.3% and NWM Canadian Tactical High Income was up 1.1%. The cash position in the NWM Canadian Equity Income is currently just over 4.0% and approximately 8% of our positions are covered.
We added a new position in Stantec and sold WSP Global Inc. As for NWM Tactical Canadian High Income, no new positions were added, but we added to our holdings in Ag Growth and KP Tissue, and sold Heroux-Devtek.
Foreign equities were negative in April, also mainly due to the stronger Canadian dollar. The NWM Global Equity fell 1.6% compared to a 2.4% decline in the MSCI All World Index and a 3.7% drop in the S&P 500 (in Canadian dollar terms).
All of our external managers were in negative territory with the exception of Mackenzie Cundill Value, which was up 0.2%. Edgepoint was down 1.6%, BMO Asia Growth & Income and Pier 21 Carnegie were down 1.9% and 4.3%.
During the month, we made a switch with our small cap managers, eliminating Templeton Global Smaller Companies and adding Lazard. NWM U.S. Equity Income was up 1.2% in U.S. dollar terms and NWM U.S. Tactical High Income gained 1.7% versus a 1.0% increase in the S&P 500.
NWM U.S. Equity Income added new positions in Costco, Disney, CVS, and trimmed Target and Dish Networks. The fund has a cash position of 3.6% and 12% is covered. NWM U.S. Tactical High Income added a new short put position in Visa.
Interest rates spiked higher in April with 2-year Canada yields increasing from 0.51% at the beginning of the month to 0.68% at the end of the month, and 10-year Canada bonds increasing from 1.36% to 1.59%.
NWM Bond held its own in April, however, down a mere 0.1% as our alternative managers generally avoid interest rate risk in their portfolios. The PH&N Short Term Bond Fund, which has a moderate interest rate, was down 0.4%, while the Marret Investment Grade Hedged Strategies Fund and the Arrow East Coast Fund were up 0.7% and 0.4%, respectively. PR Fixed Income Plus, which is unlevered and actively manages interest rate risk, was down 0.6%.
NWM High Yield Bond which has some interest rate risk, though less than a typical bond fund, was down 0.7%, mainly due to currency losses on unhedged U.S. positions.
We saw the same situation for global bonds, which declined in April with NWM Global Bond losing 2.2%. With the U.S. dollar down nearly 5% against the Canadian dollar, our two global bond managers’ U.S. dollar exposure weighed on returns.
Our mortgage pools continued to deliver consistent returns. NWM Primary Mortgage and NWM Balanced Mortgage returned 0.1% and 0.4% respectively in April, slightly lower than March, but still positive.
With interest rates moving higher throughout the month, the REIT market came under a little pressure, with the NWM Real Estate declining 0.2% in April.
The preferred share market was down in April with the BMO S&P/TSX Laddered Preferred Share Index ETF returning -0.99% while NWM Preferred Share was down -0.30%. The returns for the month hid the underlying volatility in the space. Retail investors sold en masse while institutional investors sat on the sidelines for the first 3 weeks.
The Laddered Preferred Share Index hit an intra-month low of -5.4% before strongly bouncing back in the last seven days of trading as the 5-year Government of Canada moved from 0.69% to 0.98%.
The market appears to have found a bottom with sentiment picking up and even several floaters catching a bid. In April we reduced our overweight positions in several preferred shares that we purchased in the primary market and increased our position in an oversold portion of the market; the low to mid spread rate resets that will be resetting in one to two years.
NWM Alternative Strategies was down 4.0% in April. Altegris feeder funds Winton, Brevan Howard, Millennium, and Hayman were all negative, declining 8.1%, 6.0%, 5.9% and 4.4% respectively. Ultimately, the 5% gain in the Canadian dollar hurt these funds, which use the U.S. dollar as their base currency. Another factor to consider was the dramatic jump in European bond yields.
SW8 and MAM Global Absolute Return Private Pool were both down, 3.9% and 0.7% respectively. Meanwhile, RP Debt Opportunities and RBC Multi-Strategy Trust units were up 0.8% and 0.9% respectively.
NWM Precious Metals gained 4.0% in April with gold bullion down 4.7% in Canadian dollar terms.
April In Review
The bull market remains intact as equity markets bounced back in April. The S&P 500 was up 1.0% (in U.S. dollar terms), and the S&P/TSX was up 2.4%.
The S&P 500 bull market, in fact, is now the third longest in the Index history dating back to 1928 at six years old and counting. In order to become the second longest bull market, U.S. stocks need to avoid a 10% drop between now and late April of next year, which while possible, is not without challenges.
Despite continuing to hit record highs, U.S. investors have been selling, with a Bank of America – Merrill Lynch survey recently indicating nearly $80 billion has been pulled from the market so far in 2015.
Barron’s latest “Big Money” poll also indicated a lack of conviction in the market with a record 50% of U.S. money managers neutral on the market for the rest of the year. Six years is a long time without a correction, after all, and it’s now May. Investors have learned over the years that it’s best to “sell in May and go away.”
One doesn’t need to rely on old trading adages to become worried about returns. Corporate sales and earnings are more than adequate to shake investor confidence all by themselves.
Thomson Reuters estimates first quarter earnings fell nearly 3% and analysts are forecasting a near 1% decline for the second quarter. Sales are expected to have fallen a similar 3% in Q1 with a further 3% expected in Q2.
In fact, individual stock analysts are so bearish their collective bottom-up earnings estimates for all the companies comprising the S&P 500 are lower than the market strategists’ top-down earnings estimates.
Typically, stock analysts are more bullish than strategists, resulting in the bottom-up earnings being higher than the strategists forecast. According to FactSet, U.S. companies cite the strong U.S. dollar as the number one factor negatively impacting earnings, followed by the West Coast port strike and weak oil and gas capital spending.
While the U.S. dollar strength may have been a factor in depressing first quarter earnings, it wasn’t an issue in April as the greenback fell nearly 5% against the Canadian dollar and the Euro.
With weak U.S. economic growth, and a relatively stronger Eurozone economy dimming views, the U.S. economy is diverging from the global economy. An interest rate increase by the Federal Reserve in June is all but off the table, and a September increase is looking less and less likely.
This is good news for the capital markets, and certainly contributed to the stronger equity returns in April. But then why did bonds sell off? 30-year U.S. Treasury yields jumped 20 basis points in April to end the month at just under 2.75%, and then tacked on another 25 basis in early May.
Rates in Europe rose even more, with 30 year German Bond yields soaring from 0.61% at the beginning of April to 1.31% in early May. The bond math on this kind of move is ugly for investors, with prices dropping close to 20%.
What makes the move in Eurozone yields so unexpected was that it not only broke a trend that has been in place since early last year, but that it happened while the ECB has been aggressively buying bonds for their quantitative easing program.
Don’t get us wrong, bond yields are still absurdly low, but the dramatic correction higher definitely caught many traders off guard.
Fears of deflation have been one of the reasons bond yields have been falling in Europe, and those fears lessened last month as prices look to have regained their footing.
Helping lessen deflationary fears was oil which continued to move higher in April and early May, though we are not sure why.
North American rig count and drilling activity has plunged and there are some signs that production has levelled off, but storage levels remain at 80-year highs and higher prices threaten to put idled rigs right back to work.
Also, non-OPEC producers like Russia and Brazil have actually increased production, as has Saudi Arabia. If Iranian sanctions are removed, Iran hopes to boost production by 2 million barrels a day over the next three years.
The IEA (International Energy Agency) believes that despite slower U.S. production, total global supply increased 3.2 million barrels year over year in April. Yes, a stronger European economy could help boost demand, but slower economic growth in Russia, the Middle East and Africa would likely offset much of this increase, as could lower demand from China and the United States.
When oil fell earlier in the year, many believed the drop would be temporary as declines in North American production would eventually balance the market. It may be that traders have skipped a step and not allowed prices to remain low long enough to let the market adjust.
Additionally, oil tends to move in the opposite direction as the U.S. dollar such that the recent weakness in the greenback likely provided a positive signal to traders to pile back into oil futures.
Because of this, another down leg in crude prices is possible in the coming months if the U.S. dollar bull market continues and the supply/demand imbalance in oil remains. Having said this, there are many unknowns when it comes to the oil market. Most didn’t see the dramatic correction in oil coming, so forecasting the recovery will be just as tricky.
Of course, higher oil prices would likely be a one-time event and its impact on preventing deflation should be temporary.
Expectations that the Eurozone economy has turned a corner is likely moving bond yields higher and reducing the odds of deflation. Reuters estimates first quarter GDP for the 19-country Eurozone grew 0.5%, more than both the U.S. and the U.K.
Even Italy’s economy is estimated to have expanded 0.2%. The European Union believes Eurozone GDP could grow 1.5% in 2015, up from their 1.3% forecast of only a few months ago. Goldman Sachs cites five drivers for the recent recovery: stronger external (read U.S.) growth, easier domestic financial conditions, less fiscal austerity, a weaker currency, and lower oil prices.
All very valid points, however we would point out that three of the five reversed last month. Also Greece remains at risk of going rogue and reversing labor reforms and austerity measures implemented in exchange for financial support from the ECB, without which Greece would have likely defaulted.
Yes, the Eurozone economy has probably turned the corner, but sustained growth is not assured.
We know the economy has slowed, and it has likely slowed more than the official estimate of 7% GDP growth in the first quarter, second slowest since 2001. Industrial production grew only 5.6% and Daiwa Capital Markets estimates power output in China was flat in the first quarter.
China’s imports from Australia and ASEAN (Association of Southeast Asian Nations: Indonesia, Malaysia, Philippines, Singapore, and Thailand), considered another impartial barometer of Chinese economic growth, is pointing towards a hard landing for the Chinese economy.
Pick a number, but actual economic growth in China is likely well south of 7%.
Fortunately, China’s unemployment rate is reported to be stable at 5.1% and Beijing is on track to meeting its goal of creating 10 million new urban jobs in 2015.
This is important because Beijing is attempting to rebalance the Chinese economy – moving away from being dependent on investments and exports and more towards services and consumption. It looks like they are succeeding as services contributed more than 50% of economic output for the first time in Q1.
The recent strength in the yuan is a sign of Beijing’s commitment to a more balanced economy, given a slowing economy would previously have resulted in attempts to weaken China’s currency, benefitting exporters at the expense of consumers.
Over the past 10 years, the yuan has appreciated more than 30% against a basket of currencies and, including inflation, has gained 10% on the U.S. dollar in just the past year. The IMF, in fact, recently declared the yuan as fairly valued, compared to estimates last year indicating the yuan was 5 to 10% undervalued.
Germany, who benefits from the relatively weak Euro as their currency, has passed China and now has the world’s largest trade surplus at 8.4% of GDP. Another reason we are not convinced growth in the Eurozone is sustainable.
Will they be successful? Should investors invest in China? Chinese equities have been on fire in 2015, with the Shanghai Composite up 37% year to date (in local currency) and 18.5% in April alone. This is on top of a 53% return last year.
Ominously, margin debt has skyrocketed and is estimated to fund 25% of trading on ChiNext, the Shenzhen exchange catering to startups. UBS estimates 15% of mainland China’s equity trading volume is margin financed.
Chinese leaders, however, are encouraging investment in the stock market and view equity investment as a mechanism to more efficiently allocate capital to smaller private businesses and entrepreneurs. A soaring market provides a form of stimulus in lieu of more debt financed growth.
Valuations remain “reasonable,” with Shanghai trading at 22 times trailing earnings versus 49 times in 2007, and total mainland Chinese stock market capitalization is 75% of GDP versus 90% in South Korea and 150% in the United States. Even more significantly, Gavekal notes China’s weight in the MSCI All Country Index is less than Spain’s 1.7% weight.
This is too low given China is the world’s second largest economy. By comparison, the world’s third largest economy, Japan, has a 10.6% weight. It is clearly Beijing’s goal to make yuan a more international currency and have asked the IMF to make the yuan a reserve currency.
If capital controls are removed and the yuan becomes a fully convertible currency, global asset managers will have to seriously consider increasing their allocation to Chinese stocks.
There was a big reversal in trends last month. The move into the U.S. dollar was a very crowded trade and a correction is not unexpected. Also, the rally in European bond yields bordered on the absurd, so a reversal would seem logical.
Were the fundamentals behind the moves sustainable? Is the U.S. economy still diverging from the rest of the world and destined to be the only economy with a tightening monetary policy? Or, will the weak growth in Q1 U.S. GDP portend bigger and more durable problems with U.S. economic growth?
For now, we still think the U.S. economy is the best game in town and concerns over first quarter growth will soon be forgotten. We admit we remain a little concerned. It’s just that the rest of the world is even more concerning.
The U.S. Economy
U.S. economic growth stalled in the first quarter, increasing a mere 0.2%. This first estimate is likely to be revised lower, however, as poor trade results and other economic releases have subsequently come in lower than expected. J.P. Morgan believes the real number will actually show the U.S. economy contracted 0.8% in the first quarter.
Most are blaming weather and the West Coast port strike for this, though the weather excuse seems a little old and with seasonal adjustments, one would expect weather to have been factored in. Like last year, however, it was brutally cold, particularly on the East Coast.
Also, CNBC recently pointed out the first quarter has consistently been the weakest of the year over the past 3 decades, averaging 1.87% versus 2.7% for the economy in total. Since 2010, the difference has been even greater, with the first quarter up just 0.6% versus 2.9% for all the other quarters.
Last year, first quarter GDP contracted 2.1%, before growing 5.0% and 4.6% in the second and third quarters. In addition to weather and the port strike, the strong dollar and lower oil prices also likely took a bite out of economic growth.
Macroeconomic advisors estimates decreased private investment in non-residential structures detracted 0.75% from first quarter growth, of which more than 50% could be attributed to the oil and gas industry.
As for the dollar, U.S. exports were down 1.4% in the first two months of the year versus the same period last year, and while the strong dollar wasn’t solely to blame, it was at least partially responsible. Conversely, the pickup in consumer spending expected as a result of lower gasoline prices has been slow to materialize as consumers have been reluctant to spend their unexpected windfall.
The U.S. job market got back on track last month adding 223,000 new jobs after a disappointing March in which a downwardly revised 85,000 jobs were created, the fewest in nearly three years.
Also, the unemployment rate ticked down a tenth of a percent to 5.4%, its lowest level since mid-2008. The Atlanta Federal Reserve estimates an average 270,000 new jobs a month over the next six months would drive the unemployment rate down to 5%, which according to current Federal Reserve estimates is the U.S. economy’s natural rate of unemployment. Any move below this rate would, in theory, result in inflationary pressures on the U.S. economy.
So far this doesn’t appear to be a problem, as the big disappointment with the jobs reports in April was wage growth, which remained stuck at around 2%. One of the reasons for this, is that many of the new jobs created over the past few years have been in low paying industries, which bring the average down.
The quarterly ECI (Employment Cost Index), which includes benefits and is not impacted by shifts in industry mix, is probably a better indicator for determining what is truly happening with wages, and it had been moving higher. In fact, the ECI is presently at the same level it was just before the last Federal Reserve interest rate tightening cycle began in 2004.
Inflation increased marginally in March with core CPI nearing the Federal Reserve’s 2% target level. Signs investors are feeling less concerned about deflation can be seen in the TIPS (Treasury Inflation Protected Securities) market, as breakeven rates, which is the difference between the TIPS yield and the corresponding U.S. treasury yield, have been moving higher.
The break even rate is typically used as an estimate of inflationary expectations. Higher oil prices are likely a contributing factor, with Deutsche Bank economist Torsten Slok estimating a 50% increase in oil (and it’s up about 30% from its lows already) could lift core CPI by 0.9% a year later.
Add wage growth to this and the market could very quickly shift from worrying about deflation to worrying about inflation.
Changes in consumer confidence indicators were mixed again last month, however, both remain at strong levels.
Auto sales drove retail sales, increasing 2.7%, and consumers continue to be reluctant to spend some of the money they are saving at the pump.
With credit growth remaining flat and the personal saving rate over 5%, consumers appear to be more concerned with rebuilding their balance sheets than hitting the mall. Good for them! But not so good for the economy.
New home sales also continue to increase over last year and housing starts and permits, while volatile, continue to move in the right direction; however, there remain some concerns.
Inventories of homes available for sales remain very low and the new homes that are being built have tended to cater to the affluent. First-time home buyers have been largely absent from the housing market, recently comprising only 28% of existing home sales versus 40% historically.
High youth unemployment, a dearth of well-paying jobs, high student loans, and more stringent mortgage underwriting standards, all likely pay a role in keeping millennials out of the housing market, and in their parent’s basements.
In turn, this prevents their parents from downsizing, or upgrading, as well. Nothing that a stronger economy and a tighter labour market can’t cure, it’s just taking longer than we had hoped.
The U.S. trade deficit expanded by its largest margin since 1996 in March as a resolution to the West Coast ports strike resulted in a tidal wave of imports hitting American shores. A stronger dollar and weaker economic growth in Europe and Asia also weighed on exports, which was up less than 1%.
Because the deficit was much larger than expected and has negative implications for economic growth, forecasters have brought down first quarter GDP growth estimates such that they now believe the economy contracted in the first three months of the year.
We believe U.S. growth will pick up in the second half of the year and the recovery is intact.
We are worried, however, about consumer spending.
We are seeing some early signs in the second quarter that consumer spending is not picking up, leading us to fear that perhaps there was more behind the recent soft patch than just weather. Even if this is the case, it might not be negative for investment returns as it would likely mean interest rates could stay low for longer. Maybe even QE4?
The Canadian Economy
In February, Canada’s GDP came in a little better than expected, but January’s result was revised lower. Overall, first quarter economic growth will likely show little to no growth, or even a slight contraction.
The real question is: what happens the rest of the year? And what will be the impact of a contracting energy sector, overleveraged consumer, and slower U.S. economy on the Canadian GDP growth?
On the one hand, a lower Canadian dollar helps boost growth; on the other, lower oil hurts growth, especially in the West. Complicating things, both reversed course last month, with the loonie and oil heading higher.
The IMF and Bank of Canada cut their forecast for 2015 GDP growth in April, with the IMF predicting Canada’s economy will now expand 2.2% this year while the Bank of Canada believes 1.9% is a more realistic target. Given how low economic growth is around the world, neither would be a particularly bad result.
Canada lost nearly 20,000 jobs in April, but the unemployment rate remained unchanged at 6.8%. Though the headline number was bad, the underlying quality of the employment report was less so as Canada actually added 47,000 full-time jobs while shedding 67,000 part-time positions.
Private sector jobs also grew, adding 24,000 new positions in April, while 19,900 public sector and 24,000 self-employed jobs were eliminated. We caution, however, that employment tends to be a lagging indicator and job losses from the energy sector are probably not showing in the numbers yet.
The weaker Canadian dollar took a toll on inflation in March with core CPI hitting its highest level since late 2008. The Bank of Canada believes the impact of the lower dollar, which it estimates added 0.3 to 0.4% to the core CPI rate, will be temporary in nature.
Of course they would say this, since they have no intention of increasing interest rates, despite inflation remaining above their 2% target band. If anything, the Bank of Canada might be tempted to cut interest rates if the loonie continues to rally.
Consumer confidence retreated in April, giving up all the gains recorded in March, and then some. Retail sales in February increased for the first time in three months, driven mostly by higher gasoline prices, though most subsectors also recorded gains.
February’s 1.7% gain does not make up for declines in December and January, which, combined, was the largest contraction in retail sales since the end of 2008. Still, it was a good number, especially given the poor weather experienced in Eastern Canada.
It continues to be a two-speed market for the housing market in Canada. While average home prices nationally were up 9.4% year-over-year in March, excluding Vancouver and Toronto, they were up only 2.4%.
The Canadian economy may continue to slow as a retreating energy sector hurts the West, but the impact should ease in the second half of the year, especially if oil prices continue to rebound.
A slower U.S. economy and rebounding Canadian dollar are longer term concerns.
What did you think of April’s economic activity? Let us know in the comments below!This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information presented here has been obtained from sources believed to be reliable, but not guaranteed. NWM fund returns are quoted net of fund level fees and expenses but before NWM portfolio management fees. Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value.