2015 Off To A Weak Start, With A Few Surprises - Nicola Wealth

2015 Off To A Weak Start, With A Few Surprises


Highlights This Month
 

THE NWM PORTFOLIO

Returns for the NWM Core Portfolio got off to a strong start in 2015, increasing 3.5% for the month of January. This Portfolio is managed using similar weights as our model portfolio and is comprised entirely of NWM Pooled Funds and Limited Partnerships.

NWM Alternative Strategies was up approximately 8.75% in January (these are estimates and can’t be confirmed until later in the month). Altegris feeder funds Winton, Brevan Howard, Millennium, and Hayman were up 9.0%, 12.6%, 12.7%, and 5.1% respectively in January. SW8 also had a strong month, up 11.1%, while RP Debt Opportunities increased a more modest 0.5%.

NWM Precious Metals was up 21.9% in January with gold bullion up 18.7%.

Canadian equities were marginally stronger in January with the S&P/TSX up 0.5% (total return, including dividends), while NWM Canadian Equity Income (the former Strategic Income Fund) was down 1.4%. The cash position in this Fund is currently about 3.8% and approximately 7% of our Canadian positions are covered.

NWM U.S. Equity Income was down 3.3% in U.S. Dollars. We added a new position in CBS and Schlumberger. The fund has 5.7% cash and is 12% covered.

Foreign equities were higher in January with NWM Global Equity up a strong 6.4% versus 7.6% for the MSCI All World Index, and 6.3% for the S&P 500 in Canadian dollar terms.  As for our external managers, all were in positive territory, with the BMO Asia Growth and Income Fund leading the way, up 9.1%.  Templeton Global Smaller Companies Fund was up 4.6%, while Cundill and Edgepoint were up 3.7% and 2.8% respectively.

NWM Canadian Tactical High Income, overall, was down 0.1%.  We were called away on most of our Cineplex positions, sold our entire position in Pure Apartment REIT, and added a new position in Gluskin Sheff.

As for NWM U.S. Tactical High Income, we established new naked short put positions in Disney, Oaktree, AIG, and Delta Airlines. This fund was up 0.2% versus a 3.0% decline in the S&P 500.

The preferred share market started 2015 on the wrong foot with the BMO S&P/TSX Laddered Preferred Share Index ETF down 7.3% and the overall preferred share market down 4.5%. NWM Preferred Share returned -6.0%; so while we outperformed our benchmark, our duration call continues to be a drag on fund performance.

The market is suffering a severe reaction due to issuance 5 years ago when companies came to market at very low spreads. These issues may still be under continued pressure, but the overall preferred share market is oversold at these levels, trading at very attractive spreads that we haven’t seen since the financial crisis.

The large sell-off in the market can be attributed to two events. Firstly, the surprise rate cut by the Bank of Canada caused a cascade effect on low rate resets that will be extended this year as investors became anxious over the low coupons that these issues will pay. Secondly, Royal Bank issued a massive $600-million new preferred with a very attractive reset spread of 274 bps, causing a selloff in higher reset spreads as investors re-priced outstanding issues.

The bond market rallied strongly in January, with 2-year Canada Savings Bonds declining from a yield of 1.01% at the beginning of the month to 0.39% at the end of the month; meanwhile, 10-year Canada Savings Bonds declined from 1.79% to 1.25%.  With the Bank of Canada cutting the bank rate 25 basis points and threatening another 25 basis point cut, lower bond yields and a weak currency are a logical outcome. Where do we go from here, however?  Surely, bond yields can’t go much lower?

NWM Bond was up 1.0% in January, trailing returns of PH&N Short Term Bond, which was up 1.8%. Of our alternative bond managers, RP again performed the best, up 2.2% while Merritt was up 0.6% and East Coast was down 0.6%.

High yield bonds were stronger in January with NWM High Yield Bond up 3.1% as currency, interest rates, and credit spreads all worked to provide positive returns in January.

Also having a bounce back this month was NWM Global Bond, increasing 7.5% in January as investors started shifting assets into the beaten down emerging market debt markets. With yields so low in most developed markets, investors are looking for the next area of outperformance. A weak Canadian dollar doesn’t hurt either.

The mortgage pools continue to deliver steady returns, with NWM Primary Mortgage and NWM Balanced Mortgage returning 0.8% and 0.5% respectively in January.

The Primary fund had -1.4% in cash at month end, and it also drew $2.2 million on its credit line end; while, the Balanced fund had 17.2% cash.

Lower bond yields are good for the REIT market, helping NWM Real Estate increase 5.5% in January.

JANUARY IN REVIEW

2015 got off to a rocky start with the S&P 500 falling 3% in January. Granted, the S&P 500 was up over 6% in Canadian dollar terms, but more about that later.

Historically, a weak January is both rare and ominous for the economy and the stock market. The New York Stock Exchange’s Rich Barry recently commented that January’s dip into red figures was only the eighth time the S&P 500 posted a loss after being up for three or more consecutive years.

In the seven previous occurrences, not only were stocks down for the year (by an average of 14.8%), but the economy went into recession (on average) seven months later.

Bond guru Jeffrey Gundlach also points out that if stocks do end the year in positive territory, it will be the first time in the S&P 500’s history dating back to 1875 that stocks have risen seven years in a row. In fact to find the last time they were up six consecutive years, one would have to go all the way back to 1903.

To be fair, Mr. Grundlach was likely referring to calendar years as Fundstrat’s Thomas Lee points out there have been five different periods where the S&P 500 has increased for an accumulated period of seven consecutive years, and each of these times, proceeded to go even higher.

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If U.S. stocks are to continue their rise, they will have to overcome some headwinds to corporate earnings coming from the energy sector and the strong U.S. dollar.

The greenback has been soaring against other major currencies, up 5% in the fourth quarter of 2014 and another 5% in January alone. As a result, American companies who sell products abroad will be translating their profits back to the U.S. at a lower rate, meaning less U.S. dollars.

In addition, lower oil prices, while good for consumers long term, is bad for oil companies and the companies that sell and supply the oil industry. The dramatic fall in oil prices will have immediate impact on the earnings of these companies and result in sharply lower profits.

Both these factors have earnings estimates for the S&P 500 as a whole moving lower.

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Of course the ultimate impact to earnings will largely depend on how low oil prices go, and when they will start to move back to more normalized levels, which many estimate should be closer to $70 a barrel.

Comparisons to the oil price correction of the mid-1980’s is not encouraging. After plummeting 67% between November 1985 and March 1986, it took oil nearly 20 years to recover to pre-correction levels.

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The hope is that production of shale oil will correct much quicker than in past supply cycles as companies quickly revise their spending programs.

In early February, in fact, WTI crude rallied nearly 20% on news of cap-ex cuts and sharply lower weekly rig counts, which according to Baker Hughes, hit three-year lows. The rally was short lived, however, as U.S. crude oil stockpiles were reported to have hit 80-year highs.

According to Harvard Professor Leonardo Maugeri, who in 2012 predicted a collapse in oil prices, world oil production is almost 10% greater than demand. Predicting when this gap will close is best left up to the professionals, who quite frankly haven’t done a particularly good job so far.

Some believe we have already seen the bottom, while others, like analysts at Citigroup and Bank of America, warn crude could fall to the $30 level. Eventually production will slow and prices will stabilize, but the process is likely to remain volatile.

Low oil should be a good thing, but the stock market is reacting otherwise as many fear the drop in prices could be a harbinger of slower global economic growth.

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If you think oil prices are tough to predict, try trading currencies.

Case in point, on January 15 the Swiss National Bank stunned traders by backtracking on their three-and-a-half-year pledge to keep the Franc trading at or below 1.2 Francs to the Euro. Just for good measure, they also slashed bank deposit rates to minus 0.75%.

So yes, if you really want to buy and hold Swiss Francs, you can, but you now have to pay for the privilege.

Three days previous, Swiss National Bank officials vowed the peg “would remain a pillar of our monetary policy.” Traders who believed them and shorted the Swiss Franc saw their portfolios lose nearly 18% in one day.

Keep in mind, currency speculators are able to leverage their positions by up to 50-to-1, meaning $1,000 of capital can enable a trader to take a $50,000 currency position. A 2% move in the wrong direction will completely wipe out your capital. An 18% move?

Well, you get the picture.

Brokerage firms estimate about two-thirds of traders lose money speculating in currencies during normal markets, which the current environment is not. After the move in the Swiss Franc, it was the brokers who were left holding the bag, with many becoming insolvent.

One such broker, Alpari, was a sponsor of English Premier Football (soccer) Team West Ham United and their name, up until a couple weeks ago, was proudly displayed on the front of West Ham’s jersey.

Coincidentally, West Ham’s sponsor during the financial crisis was travel agent XL, who also went bankrupt, leaving the Hammer’s with a blanked out name on the front of their shirts and open to ridicule from opposing team fans.

West Ham’s new sponsor is sports gambling company, Betway, which one could argue is in the same business as the currency brokers.

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As for the Swiss, they didn’t want their currency to appreciate. Far from it. They, like every other country in the World right now, wanted their currency to depreciate, or at least remain stable.

But the Swiss, unfortunately for them, are seen as somewhat of a safe haven in a very un-safe neighborhood. So much for that new Swiss watch you had your eye on! And forget about visiting those famous Swiss Alps. Try Italy’s instead.

Denmark and Sweden’s currencies are also under tremendous pressure. Denmark recently cut bank deposit rates four times in a two and a half week span, to a shocking minus 0.75%, matching bank deposit rates in Switzerland.

Unlike the Swiss, however, Denmark seems to be serious about keeping their peg to the Euro. You want Kroners, fine, pay us (Denmark) 75 basis points a year and we’ll take the proceeds and purchase government bonds of other countries (like Germany and the U.S.) that pay a positive spread, and we’ll pocket the difference.

The Danes are telling you they don’t want your money. Go away. Leave them alone! Funny how both the Danish and Swiss flags resemble first aid signs.

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Of course Denmark and Switzerland’s problem is not so much that their currencies are so attractive, it’s that their Euro-zone neighbors’ currency is so unattractive. And the ECB is doing everything they can to make it look even uglier.

ECB President Mario Draghi finally made good on his quantitative easing promises in January, announcing a €60 billion a month bond buying program. The details are a little confusing, but most of the risk (80%) will remain with the national central banks, thus appeasing the Germans.

The ECB maintains the goal of QE is to lower longer-term interest rates and increase liquidity in order to facilitate credit growth. Who’s kidding who here? They want the Euro to go lower.

A side benefit is QE gives the Euro-zone more leeway to deal with problem child, Greece, who elected anti-austerity party Syriza last month. Concerns of Greek debt contagion are lessened when there is a big buyer of government and corporate bonds waiting in the wings.

Expectations are very low for Europe, but forecasters might be selling the Euro-zone a bit short.  Low oil prices, a declining Euro, and now an expansionary monetary policy put the wind at their backs.

Euro-zone retail sales in December were up 0.3% versus the previous month and 2.8% compared to last year, the largest increase in nearly eight years. Purchasing manager indices were also higher in January, indicating the manufacturing sector is expanding in the Euro-zone.

While the bears focus on the problems in Greece, the bulls point out that the Spanish economy is recovering. Spain’s GDP grew 0.7% in the fourth quarter, equivalent to an annual growth rate of 2%. Nearly half a million new jobs were created in Spain last year. Existing home sales in Spain were positive in 2014, increasing for the first time since 2010.

Maybe the Germans are right about reforms?

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Of course the currency war isn’t just a European affair. Australia, Singapore, and New Zealand recently joined the Swiss and Danes in easing monetary policy in hopes of weakening their currencies.

And don’t forget the true north strong and free. The Bank of Canada’s surprise bank rate cut in January helped push a slumping loonie even lower. Of course, all these countries will have a tough time keeping up with Japan, who long ago cut interest rates down to the bone and are now on a mission to buy as many bonds as they can find in order to increase their money supply and drive the Yen lower. They are currency war veterans.

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But what about the big kid on the block, China?

The Yuan is not a free trading currency, but is closely controlled by the People’s Bank of China and pegged against a non-disclosed basket of currencies, the largest being the U.S. dollar.

China’s currency is down about 0.7% against the Greenback so far this year, and lost about 2.4% in 2014 — the first annual decline in the yuan against the dollar since 2009. Still, a 2 or 3% decline against the dollar means the yuan is actually gaining ground against most of China’s peers.

For example, the Japanese yen depreciated almost 14% against the U.S. dollar in 2014. It’s fine to have a strong currency if your economy is healthy and growing, but it’s not clear this is the case for China.

Purchasing manager indices are signaling China’s manufacturing sector is either contracting, or close to it. GDP grew only 7.3% in the fourth quarter, lowering full year growth to 7.4%, below Beijing’s 2014 target of 7.5%.

The IMF is forecasting growth will fall to 6.8% in 2015, while Oxford Economics is more pessimistic, forecasting that not only will 2015 GDP growth slow to 6.5%, but that this will in fact be the last year the Chinese economy posts a growth rate in excess of 6%.

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While China’s growth rate is slowing, the debt Chinese companies and local governments are accumulating is accelerating.

China is getting a diminishing return on their investment with more and more debt required to generate less and less growth. Last year alone, China spent an estimated $5 trillion on fixed income investments, more than Europe and America combined. It is estimated that total debt in China (government, personal, and corporate) has risen from 100% to 250% of GDP in just the last eight years.

To put this in perspective, Japan saw total debt increase by an amount equivalent to 50% of GDP in the period preceding its lost decade of economic growth. While it is true China is trying to rebalance its manufacturing and export oriented economy to be more focused on consumer spending, there are risks in letting it swing too much too fast. Many feel China might be inclined to help ease the transition by devaluing the yuan.

In early February, the Chinese central bank lowered the reserve ratio for commercial banks by 50 basis points.

While the move was likely intended more to help bank profits than increase lending, many feel it could also signal Chinese authorities are becoming increasingly concerned about the slowing economy. Interest rate cuts and currency devaluation could be in the cards.

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So the entire world is embroiled in a currency war? Well no, not quite.

Given the strength in the U.S. economy, which we go over in more detail below, the U.S. appears to be playing the role of Switzerland in this war by signaling their intention to raise interest rates, thus allowing the U.S. dollar to become the global safe haven of choice and appreciate sharply higher.

But can the U.S. afford to stay on the sidelines indefinitely? How high can they let the dollar go before it starts to negatively impact the U.S. economic recovery?

These are the question traders grapple with every day, and one of the reasons market volatility has increased this year, and will probably continue to increase the rest of the year.

Just the absence of quantitative easing has historically resulted in higher volatility. And actually increasing interest rates? Well, markets are likely to get a whole lot more interesting.

We still like stocks given a stronger U.S. economy, and we think the risk versus return trade off versus bonds is still attractive, but we recognize the road will not run in a straight line.

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The U.S. Economy
 MMC 2015 - 02 Economic Growth TableFourth quarter GDP growth came in a little light at 2.6% versus expectations of 3.2%. Slower business investment, declining government spending, and decelerating export growth all detracted from growth.

Durable goods orders were particularly weak in December and have fallen four of the past five months.

On the positive side, consumer spending remains strong and was up 4.3% in the quarter. For 2014 as a whole, GDP grew 2.4%, slightly above the 2.2% average pace the previous four years, but considerably slower than the average 3.4% growth experienced in the 1990’s.

Although we are seeing some signs the U.S. economy might be reaching takeoff velocity, the recovery from the great recession has been slower than recent economic recoveries.

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Two factors are likely to weigh heavily on the prospects for U.S. economic growth in 2015: oil prices and the health of the global economy.

Lower oil prices will help the consumer, and we might already be seeing the positive impact, but what will it do for business investment and capital expenditures?

Bond guru, Jeffrey Grundlach, believes there is a possibility corporate capital expenditures could collapse, citing the fact that 35% of S&P’s cap-ex comes from the energy sector. Business spending might only comprise 13% of U.S. GDP, but it was responsible for about a third of the growth in the economy last year.

And don’t expect exports to make up the difference. Both the World Bank and IMF recently lowered their estimates for global GDP growth, with both showing the U.S. as one of the only countries where growth forecasts have brightened.

Like energy sector capital expenditures, export growth is likely to turn from being a contributor to U.S. economic growth to a drag on growth, made even more acute by the sharp appreciation of the U.S. dollar.

Fortunately, consumer spending is what drives the U.S. economy, and a stronger consumer should more than offset weaker export growth and energy related cap-ex.

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MMC 2015 - 02 Employment Table

January was another strong month for the U.S. job market with over a quarter of a million new jobs created. Over the past three months, the U.S. has added more than a million jobs, the strongest three month hiring spree since 1997.

The unemployment rate ticked slightly higher to 5.7%, but only because the workforce grew by over 700,000, as evidenced by the 0.2% decline in the labor-force participation rate. The Challenger Job-Cut Report indicated more workers were laid off in January, but a large part of the increase from December came from the energy sector.

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The fact that job creation remains strong is good news, but the number most analysts have their eye on is wage inflation, and here the picture is much murkier.

Despite the unemployment rate moving closer and closer to the Federal Reserve’s full employment target of 5.2% to 5.5%, wage growth has disappointed.

There are many theories as to why, but most blame the large “shadow” pool of discouraged workers sitting on the sidelines, who have given up actively seeking work, but stand ready to re-enter the work force and thus act as an overhang for wage growth.

The length and severity of the Great Recession has also made workers insecure and afraid to switch jobs.

The San Francisco Federal Reserve believes employers didn’t cut wages as much as they would have liked during the recession, and the current stretch of meager pay increases is a catch up period.

Also, the composition of new job creation likely explains part of why wage growth has lagged as many of the new jobs created have been lower paying retail and food service positions. The Employment Cost Index, a report compiled by the Labor department and released quarterly, is designed to take these shifts into account by using fixed weights for industries and occupations.

While showing total compensation growth is higher than just straight hourly pay increases, the Employment Cost Index is still indicating salary growth is well below pre-recession levels.  Without wage growth, many feel the Federal Reserve will be reluctant to increase interest rates, fearing the slack in the labour market is still too high.

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So are we seeing any signs of wage growth? Maybe.

January wage inflation moved up slightly, though this is compared to a weak December number.  The Labor Department’s job openings, hiring and firing report (JOLTS) indicated American companies had about 4.97 million openings in November after hiring 4.99 million workers.

This ratio of openings to hires is at a historically high level and indicates companies are finding it hard to hire workers as quickly as they have in the past.

In addition, a survey by the National Federation of Independent Businesses recently indicated companies are at their highest level of optimism since 2006, and 17% more companies expect to increase compensation over the next three months than decrease — the most favorable spread in this comparison since 2007.

President Obama actually used the NFIB survey in his State of the Union Address as the basis for making the comment that wage growth is firming. Let’s hope he is finally right, because the market’s been consistently pre-mature in forecasting a recovery in wage growth and it is desperately needed if the current economic recovery is to have any legs.

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MMC 2015 - 02 Inflation TableInflation continues to be a concern for the Federal Reserve and their timing for a shift in interest rate policy.

The Personal Consumption Expenditures Price Index, the Federal Reserve’s preferred inflation benchmark, increased an anemic 0.7% in December, the smallest 12-month gain since October 2009.

It was also the 32nd month in a row the PCE Index came in below the Fed’s 2% target level. CPI and Producer Price Indices also reported low headline numbers, with month-over-month changes actually negative.

Core inflation indices, that exclude food and energy, were stronger, indicating lower energy prices likely weighed heavily on results in December. A strong dollar was also a big factor.

Current price indices are important, but what policy makers really care about is inflationary expectations.

By comparing the difference between the yields on treasury bonds and treasury inflation protected securities (TIPS) of similar terms, a break-even rate can be calculated which indicates the implied future inflation rate investors expect.

Currently the 10-year break-even rate has declined to about 1.6%, indicating investors believe inflation over the next 10 years will remain well below the Fed’s 2% target. By using the current 5-year break-even rate, forecasters are also able to calculate the 5-year forward break-even rate, or in other words, the 5-year inflation rate in five years.

At 1.86%, the inflation rate expected between 2020 and 2025 has plummeted over 70 basis points in the past six months and is at its lowest level since late 2000. These indicators are hard to ignore, especially given the lack of wage inflation cited above.

We expect inflation to trend higher, but the lack of inflationary expectation is a key variable to watch in determining how aggressively the Federal Reserve will increase interest rates.

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MMC 2015 - 02 Consumer Confidence Table

American consumer confidence is riding high, with the Conference Board Consumer Confidence Index at its highest level since August 2007. A strong dollar, low gasoline prices, and the recovering job market are key contributing factors.

MMC 2015 - 02 The Consumer Table

December retail sales were down 0.4% excluding gasoline, and 1.0% not including auto sales.  What was up in December was the personal savings rate, as consumers appear to be saving more of their disposable income.
Considering the strength in consumer confidence, forecasters were even more surprised when it was reported retail sales actually declined in December
, falling 0.9% — the largest monthly decline since January 2014.

A recent survey conducted in early January for Visa found consumers were saving about half of the windfall accruing to them from the sudden decline in gasoline prices, which according to industry estimates, translates to approximately $60 per month.

While we commend this new found parsimonious behavior, we suspect it will be short lived and future gains will find its way into the hands of retailers, and the economy in general.

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MMC 2015 - 02 Housing Table

Existing home sales ended the year on a strong note, but overall, 2014 was a disappointing year for the housing market with sales for all of 2014 down 3.1% from 2013 levels.

A stronger labour market could be the key to getting the housing market recovery back on track, however.

Growth in home sales starts with first-time buyers, which in turn is dependent on household formation. High youth unemployment and under employment has meant many millennials have been forced to live in their parents’ basements rather than buy a home.

Household formation spiked higher in 2014, however, increasing at its fastest pace since 2005.

This, along with mortgage foreclosures, has resulted in U.S. homeownership rates in 2014 declining to their lowest levels in 20 years, indicating there is a growing pent up demand for housing in the U.S. market.

We remain a believer.

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MMC 2015 - 02 Trade TableSo is anyone surprised the U.S. trade deficit in December jumped to it largest deficit since May 2012?

A weak global economy and a strong U.S. dollar all but sealed the balance of trade’s fate.  Based on these numbers, most forecasters will likely revise down estimates for GDP growth in Q1 2015.

The U.S. economy remains on the mend, driven by a recovering job market, and hopefully a resurgent housing market. We are, however, concerned about the impact of energy and a strong U.S. dollar.

The U.S. consumer is not strong enough to drive global economic growth higher on its own.

The Canadian Economy

MMC 2015 - 02 Canadian Economic Growth TableCanadian GDP declined 0.2% in November, but this wasn’t really the story last month.

It was the Bank of Canada’s decision on January 21st to cut overnight interest rates.

By cutting the bank rate 25 basis points to 0.75%, the first reduction in the bank rate since April 2009, the Bank of Canada succeeded in catching global markets off guard.

While the loonie had already been declining, the move helped accelerate the Canadian dollar’s decline as it eventually traded below the 80 cent level. The move was puzzling given most believed the Bank’s next move would be to actually raise rates.

With concerns of high consumer debt levels and a hot real estate market, the last thing it was believed Canada needed was lower interest rates.

What was the Bank of Canada seeing that the rest of us were not?

Lower oil prices and the impact it would have on the Canadian economy is clearly the answer.

While one can debate the net positive or negative impact oil might have on the U.S. economy, one only has to look at a historical chart comparing the loonie versus WTI oil to see the strong correlation between the two.

About 13% of the Canadian economy is either directly or indirectly derived from the energy sector, and 20% of every dollar spent on cap-ex is energy related. Accordingly, the IMF cut Canada’s growth rate in 2015 to 2.3%, and 2.1% in 2014 versus 2.4% in both years previously.

For its part, the Bank of Canada believes lower oil exports could trim economic growth by 4.5% between now and the end of 2016.

Adding to perceptions that the Canadian economy was on the skids, the Bank of Canada’s action followed days after Target announced they were closing up shop in Canada, shuttering 133 stores and laying off 17,600 workers.

Totally unrelated, but disconcerting for foreign investors who may not have done their homework on Canada.

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MMC 2015 - 02 Canadian Employment Table

While the topline number of 35,400 new jobs in January sounded like good news, the reality is somewhat different.

More than all the gains were comprised of part-time jobs, as Canada actually lost 12,000 full-time positions. Same for self-employed jobs — which rose by 41,000 — while 5,700 salaried positions were lost.

The Bank of Canada believes that even though the recession ended five years ago, the Canadian economy is still 270,000 jobs short of full employment levels, and doesn’t expect the economy to reach full employment levels until late 2016.

Even more concerning, unemployed workers are taking 21 weeks on average to obtain new jobs, and a quarter of those working part-time would rather be working more.

It wasn’t too long ago the Canadian job market was outperforming the U.S. job market as Canada quickly recovered from the recession while U.S. job creation lagged well below previous economic recoveries.

Now the reverse is true, and along with lower oil prices, is a big factor behind the decline in the Canadian dollar.

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MMC 2015 - 02 Inflation Table

The good news with a falling currency is inflation should move higher.

I know this sounds absurd, but with most of the developed world worried about deflation, a little inflation isn’t considered a bad thing — particularly if wage inflation is also moving higher.

Fruits and vegetables, which along with nuts comprise about a quarter of a typical Canadian’s grocery bill, will likely be the hardest hit as most of Canada’s produce comes from south of the border.

While cheaper fuel prices should help lower transportation costs, supply is being pressured by droughts in states like California.

MMC 2015 - 02 Canadian Consumer Confidence-The Consumer Tables

Consumer confidence remains strong in Canada as were retail sales in November. Also strong in November was credit growth, which increased an annualized 4.5%.

Scotia Capital estimates that lower gasoline prices could save Canadians about $13 billion in 2015, with Ontario and Quebec accruing the majority of the benefit. Ontario and Quebec should also see the majority of the job gains from lower energy prices and the fall in the Canadian dollar.

The real question is, will the benefit to Ontario and Quebec outweigh the negative impact falling oil prices will have on Western Provinces, particularly Alberta?

The price action in the Canadian dollar says no.

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MMC 2015 - 02 Canadian Housing Table

Growth in the Canadian housing market has largely been driven by three markets: Toronto, Vancouver, and Calgary. Going forward, it will likely have to rely on just Toronto and Vancouver.

Existing home sales in Calgary fell 35% in December and listings are up 40%. Prices are largely unchanged, however, as it may take a few months for sellers to realize their homes are no longer worth as much as they thought.

Many have been predicting the demise of the Canadian housing market for years, but without higher interest rates or dramatically higher unemployment rates, there has been no catalyst to drive prices lower.

Lower oil prices could be that catalyst, as jobs will be lost. However, even if this is the case, the Canadian housing market is not like the U.S. housing market that helped trigger the financial crisis.

Canadians typically have higher home equity, tend to pay down their mortgages, and know who they are borrowing from (meaning mortgages aren’t bundled up and sold to investors).

We expect the housing market in Canada will slow, maybe even correct, but we don’t see a crash.

MMC 2015 - 02 Canadian Trade Table

Despite widening in December, the trade deficit was good news for Canada, mainly because forecasters were expecting an even wider deficit.  Despite the 12.3% drop in oil prices, exports actually grew in December as volumes increased.

Stronger U.S. growth and a weaker Canadian dollar were major contributors, with energy volumes up 2.3%, while non-energy exports increased 4.9%.

Also positive was the 2.3% increase in imports, which indicates the domestic economy remains robust for now.

There are offsets for a Canadian economy dependent on housing and energy.

A lower Canadian dollar and a stronger U.S. economy should help mitigate some of the fall out.

Canada appears to be winning the currency war after the shock and awe campaign waged by the Bank of Canada in January.

Time will tell if it is enough.

 

Let us know your thoughts on January’s market activity 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.