Highlights This Month
- WILL WE SOON SEE THE END OF THE BULL MARKET?
- THE IMPACT OF THE U.S., EUROPE AND JAPAN’S SYNCHRONIZED GROWTH.
- AN UPDATE ON GREECE’S SMALL DISASTROUS ECONOMY.
- IS PANIC WARRANTED OVER CHINA’S RECENT MARKET DECLINE?
- THE CORRELATION BETWEEN LOW OIL PRICES AND THE CALGARY STAMPEDE.
- GOOD NEWS: U.S. CONSUMER SPENDING, HOUSING MARKET ON THE RISE.
- WHY IS WAGE GROWTH STILL LAGGING IN A STRONG U.S. ECONOMY?
- A LOOK AT RECENT IMPROVEMENTS IN THE HOUSING MARKET.
- OUR PREDICTIONS FOR A SEPTEMBER U.S. INTEREST RATE INCREASE.
- IS CANADA EXPERIENCING A RECESSION? A LOOK AT THE NUMBERS.
The NWM Portfolio
Returns for NWM Core Portfolio decreased 0.5% for the month of June. NWM Core Portfolio is managed using similar weights as our model portfolio and is comprised entirely of NWM pooled funds and limited partnerships. Actual client returns will vary depending on specific client situations and asset mixes.
Canadian equities were weaker in June, with the S&P/TSX down 2.8% (total return, including dividends). NWM Canadian Equity Income (our former Strategic Income fund) lost 0.9% and NWM Canadian Tactical High Income declined 1.3%, both outperforming in a down market. The cash position in NWM Canadian Equity Income is currently 5.1% and approximately 4% of our positions are covered.
We added Agrium to the portfolio, using the proceeds from Methanex, which was called away. We also trimmed our position in TransCanada and added to our Sun Life and Manulife positions. As for NWM Canadian Tactical High Income, no new positions were added, but we increased our existing positions in Ag Growth, Guardian Capital, KP Tissue, and Gluskin Sheff.
Foreign equities were also weaker in June, with NWM Global Equity down 1.3% compared to a 2.1% decrease in the MSCI All World Index and a 1.8% decline in the S&P 500 (in Canadian dollar terms). Of our external managers, Lazard Global Small Cap led the way with a 1.1% gain, followed by Pier 21 Carnegie and Edgepoint, down 0.3% and 0.6% respectively. Both these managers have higher relative exposures to U.S. equities.
BMO Asia Growth & Income and Mackenzie Cundill both have higher relative exposures to Asian equities and were down 2.6% and 2.8% respectively. NWM U.S. Equity Income was down 1.8% in U.S. dollar terms and NWM U.S. Tactical High Income 1.5% versus a 1.9% decrease in the S&P 500. For NWM U.S. Equity Income, we added new positions in Visa and AIG. The fund has a cash position of 2.8% and 15% of the fund is covered. As for NWM U.S. Tactical High Income, we added a new position in Home Depot.
The Canadian yield curve steepened again last month, with 2-year Canada bond yields decreasing from 0.57% at the beginning of the month to 0.48% at the end of the month while 10-year Canada yields increased from 1.62% to 1.68%.
The U.S. yield curve also steepened, but only because long rates backed up more than short-term rates. 10-year U.S. treasury yields ended the month at 2.35%, up 23 basis points. NWM Bond was down 0.2%, with the PH&N Short Term Bond Fund — which benefited from the decrease in short-term rates — up 0.3%. Our alternative managers were all down 0.4% to 0.6%.
High yield bonds were also lower in June, with NWM High Yield Bond down 0.5%. Currency was not an issue in June, with the Canadian dollar down a mere 0.3% versus the U.S. dollar.
It was the same for global bonds, with NWM Global Bond down 0.5%. Emerging market debt has come under pressure given concerns over higher U.S. interest rates and market volatility in China and Europe. Not all emerging market economies are equal, however, and the recent sell off has resulted in some attractive valuations and yields.
The mortgage pools continued to deliver consistent returns, with NWM Primary Mortgageand NWM Balanced Mortgage returning 0.3% and 0.5% respectively in June.
The Primary had 5.2% in cash at month end, but could move up closer to 13.5% given expected maturities during the month. The Balanced had 8.3% in cash, but could move down to 1.4% if all mortgages pending and in negotiation close, and mortgages scheduled to be re-paid over the next 90 days are not extended.
The S&P/TSX Laddered Preferred Share Index ETF continued its downward trend for the month of June, reaching new lows at the end of the month down 3.7%, matched by the returns of NWM Preferred Share. We increased our weight in Enbridge after the S&P downgrade from P-2 to P-2L. The selling pressure caused by investors prepositioned for a downgrade below investment grade was overdone and it appears as though Enbridge preferred shares have found a floor with a current average yield of 5.55%.
Higher interest rates continue to provide a headwind for REIT’s, with NWM Real Estatedown 0.5% while the iShares REIT ETF decreased 1.4%.
NWM Alternative Strategies was down 0.8% in June (these are estimates and can’t be confirmed until later in the month). Of the Altegris feeder funds, Winton, Brevan Howard, and Hayman were down 3.0%, 1.3%, and 2.7%, while Millennium managed a 1.3% gain. MAM Global Absolute Return Private Pool, RP Debt Opportunities, and RBC Multi-Strategy Trust were also lower, returning -1.3%, -0.4%, and -0.7% respectively. Polar North Pole Multi Strategy was positive, gaining 0.1%.
Rounding out a challenging month, NWM Precious Metals lost 2.2% in June, with gold bullion down 1.3% in Canadian dollar terms. Given the turmoil in Greece and China, gold’s performance was particularly disappointing as gold typically outperforms when markets are volatile and geopolitical factors are elevated.
Likely, the strength in the U.S. dollar and the perceived negative impact an increase in U.S. interest rates would have on gold was responsible for the negative market action last month.
June In Review
Equity markets came under some pressure in June, with the S&P/TSX down 2.8% and the S&P 500 -1.9% (in U.S. dollar terms). While declines are never a good thing, and these declines might appear high, it’s likely because the market has been unusually quiet.
Up until the week of June 15th, it had been eight weeks since the S&P 500 had moved at least 1%, either up or down, the longest the market had gone without such a weekly move in 21 years.
Until June 26th, when the S&P 500 fell 2.09%, it had been 130 days since the last 2% daily move in the market — the longest such streak since February 2007. A few more trading sessions and the S&P 500 would have gone without a 2% daily move in the first half of the year for the first time since 2005.
Of course, it’s been over six years (or 2,093 days as of the end of June to be exact) and counting since the S&P 500 has suffered a cumulative 10% correction — the third longest bull market in history.
While we are not of the mind the demise of the current bull market is imminent, we do suggest the recent period of low volatility could be coming to an end for a number of reasons. The most important reason being the threat of an increase in U.S. short-term interest rates.
Historically, the start of a Fed tightening cycle hasn’t translated into lower stock prices. Only later in the tightening cycle, once the economy has started to slow, has the market turned lower.
We are nowhere close to this presently, and we think this tightening cycle will be much slower than previous cycles. Of course this is where the volatility and uncertainty comes in.
The market and the Federal Reserve appear to be operating on two different wave lengths in regards to where overnight money is headed over the next couple of years.
Assuming we are right and the Fed increases rates no more than just a token amount over the near term, the next biggest threat to stocks is corporate earnings.
Second quarter earnings are estimated to fall 4.5% in the second quarter, which would be the first year-over-year decline since the third quarter of 2012.
Much of the damage is taking place in the energy sector, however. If the energy sector were excluded, estimated S&P 500 earnings would actually increase 2% in Q2. Not a disaster, but somewhat concerning for a market trading at valuations above the 10-year average.
Of course, every company and Wall Street analyst is trained to under-promise and over-deliver when it comes to earnings. Case in point, Q1 earnings were estimated to decline 4.9% but ended up increasing 0.8% with energy, and 8.6% without it.
If the second quarter is able to again provide a positive surprise, valuations could continue to move higher, as they have done in the past three market cycles.
We think the recent strength in the U.S. economy, which we describe in more detail below, will provide support to corporate earnings.
Yes, synchronized global growth should mean interest rates move higher and will provide a headwind for fixed income returns in the near term, but this is a good thing. Bond yields are still trading at crisis levels, and the global economy is no longer in a crisis.
Well, unless of course you are in Greece, which appears permanently stuck in crisis mode.
In early July, however, the tragedy that is Greece elevated to a new level as the odds of a Greek exit from the Eurozone increased dramatically with 61% of Greek voters backing Prime Minister Tsipras in turning down the ECB’s last austerity/bailout offer.
Actually, the ECB had withdrawn the offer before the referendum, but the outcome of the vote made this detail rather academic. In doing so, Greece became officially “late” in making a €1.56 billion payment to the IMF, which was actually due on June 30th, just before the referendum.
Greek Prime Minister Tsipras is still hoping to do a deal with his Eurozone counterparts and stay in the Eurozone and is bargaining the support of the Greek people. The threat contagion from a Grexit would spread to Italy, Spain and Portugal and will pressure the ECB to cut Greece some slack.
So far, however, the ECB has been able to contain the fall out, with 10-year bond yields falling in most Eurozone countries.
The ECB is caught in a tough spot. No one wants to see Greece quit the Euro, but if they back down, the ECB gives every left wing anti-austerity party in Europe a road map to gaining concessions themselves.
Markets care, not because Greece is vital to the global economy; it is not. Factset recently pointed out that during S&P 500 company conference calls in June, despite the recent dramatic decline in economic growth, Greece wasn’t mentioned once by anyone.
At about 2% of Europe’s GDP, Greece is a small economy. It’s what happens next and what it might mean for the future of the Euro that has the market on edge, and as such, we have no choice but to continue to watch.
Wall Street traders have coined it “Gretigue”, or fatigue of all things Greek. Everyone is tired of Greece, but it just won’t go away.
While the Greek economy might not be important to global markets, the Chinese economy, as the world’s second largest, certainly is. Which is why the recent slide in Chinese equities is concerning.
As of June 12, the Shanghai Composite Index was up a remarkable 60% for the year, and an astounding 160% over the past 12 months. As of July 8th, a mere 17 trading days later, the index had shed 32% and erased nearly $3 trillion in value, despite efforts by Beijing to do everything in their power to stop the slide.
China’s central bank cut interest rates and bank reserve requirements, the country’s largest brokerage firms established a $19 billion fund to buy stocks, IPO’s (new issues) were restricted in order to preserve market liquidity, and trading in certain stocks was suspended.
Unlike the situation in the Eurozone, the carnage was not contained and the contagion spread to the Chinese bond and currency markets. More problematic for global investors, however, the contagion also spread to commodities like copper and even oil.
China is the world largest consumer of copper and a growing customer to oil exporters around the world.
If something is wrong with the Chinese economy, prices of these and many more commodities will continue to head lower.
But is this what the Chinese stock market is telling us?
An explosion of margin lending, which tripled over the past year, and at nearly 9%, is a record — not just for China, but for any market.
Investors who are selling aren’t making a statement about China’s economic future. According to Bloomberg, 60% of new traders stopped going to school in junior high, and 6% can’t even read! They don’t know anything about balance sheets or macroeconomics, they just want to make money.
Beijing supported the move as a buoyant stock market gives the over-leveraged corporate sector another source of capital. The wealth effect for investors also suited the government’s plans of rebalancing the economy towards being more oriented toward consumer spending.
The reality, however, is the equity markets in China are still quite small and most corporations still rely on other avenues for their capital needs.
As for the wealth effect, according to HSBC, stocks represent less than 15% of a Chinese household’s financial assets with real estate remaining the preferred investment choice, by far.
So why is Beijing panicking? Job number one for any Chinese government is to preserve stability, economic as well as social.
The fact that Beijing has not been able to slow the market decline brings into doubt the government’s ability to control the economy in general and certainly adds doubt around Beijing’s 7% GDP growth target.
Case in point, the Shanghai Composite fell more than 2% on June 15th, which shocked investors given it was President Xi Jinping’s birthday.
Again, this is not a sophisticated market. Traders aren’t using fancy algorithms and relying on fundamental research. Like any market, however, the underlying driver is confidence, and confidence is shaken.
If this lack of confidence spills over into the real economy, China could be in trouble.
For Canada, the spill-over effect is already being felt, with crude oil giving back over half the 30% recovery recorded since early May after falling over 50% in price last year.
While traders point to China as a contributing factor, as well as Greece, production is still higher than demand and is likely the main factor behind the slide in crude prices.
Not only is OPEC producing more oil and Iran likely to add over a million barrels a day if sanctions are removed, but U.S. production continues to move higher. Rig count in the U.S., which has been moving lower since December, looks to have bottomed, and inventories in late June increased for the first time in nine weeks.
On top of this, oil is denominated in U.S. dollars and a stronger U.S. dollar usually drags crude oil prices lower.
Uncertainty in Greece and China, or anywhere else for that matter, usually means the greenback is going higher.
While we will discuss the Canadian economy in more detail below, one only has to look at the historical correlation between oil prices and Calgary Stampede revenue to see how lower crude prices can impact corporate Canada.
This year, Stampede organizers reported three official corporate sponsors have backed out and onsite corporate event bookings are down 10% as many companies have cancelled Stampede-themed parties and events.
For the city of Calgary, it’s sort of like cancelling Christmas.
The U.S. economy, corporate earnings, and interest rates are what counts for the markets in the short term.
Greece and China make for good headlines and help increase volatility, but their real impact on the economy is minimal.
First quarter GDP was again revised higher, with expectations the final revision could show the U.S. economy broke even in Q1.
If the second quarter matches expectations of around 2.5%, economic growth in the first half of 2015 could match 2014’s pace. In fact, full year GDP is also expected to nearly match 2014’s 2.4% pace, higher than the 1.8% to 2.0% range the Federal Reserve projected in early June.
Confirmation that wage growth is breaking out would be the remaining piece in the puzzle.
The U.S. added a respectable 223,000 jobs in June and the unemployment rate, at 5.3%, fell to its lowest level since April 2008.
April and May’s figures, however, were revised down a cumulative 60,000 such that the U.S. has averaged 208,000 new jobs a month in the first half of the year, which is decent, but slower than last year’s 260,000 a month pace.
More disappointing, however, was hourly wage growth, which slumped back down to 2% year-over-year growth, and the participation rate, which moved to its lowest level since 1977 with 432,000 workers dropping out of the labour market.
It’s not that there aren’t any jobs. The April JOLT (Job Openings and Labor Turnover) job openings report indicates there were a record 5.4 million job openings in United States, exceeding the number of hires by 369,000.
This is unusual as hires typically outnumber job openings and could indicate companies are struggling to find the right skills. Perhaps they should think about paying more.
We look forward to seeing the ECI (Employment Cost Index) and ECEC (Employer Cost for Employee Compensation) Wage Index for the second quarter as they are a better indicator of wage growth, the one missing puzzle piece.
The Personal Consumption Expenditures Index — the inflation index preferred by the Federal Reserve — recorded its highest monthly increase in more than two years in May, though the year-over-year number came in below the Federal Reserve’s 2% target level for the 37thconsecutive month.
Declining commodity prices and a strong U.S. dollar have provided a deflationary headwind on price levels over the past several years, but should be close to winding down. If this is the case, inflation should gradually transition back towards the 2% level.
Along with geopolitical risks, such as Greece and China, low inflation is cited as one of the biggest reasons why the Federal Reserve might delay increasing interest rates in September.
Both consumer confidence indicators were higher in June, which bodes well for retail spending.
Finally, the U.S. consumer has come out of hibernation!
Consumer spending in May increased at its fastest rate in nearly six years and retail sales recorded its biggest jump since August 2009.
One of the major economic disappointments this year has been the decline in gasoline prices, which has increased disposable income but hasn’t resulted in an increase in consumer spending.
May’s results indicate consumers may finally be spending some of their lower gasoline price windfall. The improved employment market is also likely a factor.
Good news on the housing front! Existing home sales increased at their strongest pace since November 2009 while new home sales surged to their highest level in seven years.
Encouragingly, first time buyers represented 32% of existing sales versus 27% last year. First time buyers have been largely absent from the market since the financial crisis but are crucial to a sustainable recovery in the housing market.
Even more important for economic growth, building permits hit their highest level since August 2007, indicating that new home construction is gaining momentum.
Housing starts pulled back in May, but only compared to a very strong April which saw groundbreakings hit a seven year high.
One negative to keep an eye on is mortgage rates, which tend to track 10-year treasury bond yields and increased in June in line with interest rates. The negative impact could be short-lived, however, as bond yields fell later in the month.
Also, Zillow believes even if mortgages rates moved up to 5%, a typical home buyer would still need only 17% of their income to service the mortgage on a typical home compared to 30% if they were to rent.
The U.S. trade deficit widened a modest 3% in May as a stronger dollar and global economic weakness weighed on exports. Helping keep the deficit in check, however, has been oil imports, which have been moving consistently lower in recent years and hit their lowest level since February 2002 in May.
Trade is likely to remain a drag on U.S. economic growth for the remainder of the year, though the magnitude will likely depend upon strength in overseas economies, especially Europe.
A rebound in consumer spending and a recovering housing market is welcome news for the U.S. economy. The job market also continues to move in the right direction, with only wage growth being the one negative.
The U.S. economy would appear to be strong enough for the Federal Reserve to increase interest rates in September, but concerns over weak growth overseas and the impact an increase in interest rates could have on the dollar might hold them back.
Canadian GDP declined for the fourth straight month in April, mainly due to a 3.4% drop in oil and gas extraction. Even worse, it looks like the economy contracted closer to 1% in the first quarter versus previous estimates of 0.6%.
Given April’s poor start to the second quarter, Canada could technically be in recession (defined as two quarters in a row of negative growth).
The decline in oil and gas could be temporary, however, and the housing sector remains strong.
It’s a close call whether the Bank of Canada will cut rates again. Lower interest rates likely won’t provide any direct relief to borrowers given rates are already so low, but the move could put additional downward pressure on the Canadian dollar, which would benefit exports.
Canada lost 6,400 jobs in June, but this was only as a result of 71,000 part-time jobs being eliminated. Canada created 65,000 new full-time jobs and wage growth and hours worked were both strong.
The unemployment rate was unchanged, and even in Alberta, the unemployment rate was remarkably resilient, falling to 5.7%. Employment tends to be a lagging indicator, however, so the job market might catch up to the weak Canadian economy in future months.
Energy prices continue to weigh on inflation, but the impact from the lower Canadian dollar could result in inflation moving higher over the coming months.
Consumer confidence remains strong, but retail spending has yet to rebound from its poor start to the year. Big ticket purchases, particularly housing and auto, appear to be drawing spending away from smaller more general retail purchases.
Exports fell for the fifth month in a row as Canada’s trade deficit widen more than expected.
Surprisingly, however, it was non-energy exports that were responsible for the decline as higher oil prices drove energy exports higher for the second month in a row. Either way, it’s bad for GDP growth.
Thank goodness for the housing market and our benevolent U.S. neighbors.
The negative impact from declining oil prices looks to be more durable than originally forecast and will likely creep into the second half of the year.
Because of this, GDP growth estimates for 2015 will be revised lower. Barring a correction in the housing market or a slow-down in the U.S. economy, however, the impact should be manageable.
What did you think of June’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.