- What is driving stock prices higher?
- Global investors looking away from Canadian markets.
- Is it time to buy gold?
- Europe is barely holding together.
- The Eurozone Central Bank Playbook.
- Is there a global currency war on the horizon?
- U.S. housing continues to recover.
- It’s slow going, but the U.S. dollar should continue to appreciate.
- Can the Canadian housing market expect a soft landing?
The NWM Portfolio
It was a mixed month in April as gold and Canadian equities traded lower, while global equities continued to rally.
The bond market had a decent month with the NWM Bond Fund up 0.3%. Interest rates trended lower with 2-year Canada’s going from 1.0% at the end of March to 0.92% at the end of April. Likewise, 10-year Canada’s declined from 1.87% to 1.70%.
High yield bonds also had a good month, with the NWM High Yield Bond Fund gaining 0.9% in April as credit spreads continued to compress. High yield bonds are looking a little toppy (over valued).
Global bonds continued the good showing for fixed income, with the NWM Global Bond Fund increasing 0.7% – a good result given the 1% rally in the Canadian dollar.
Mortgage returns were steady as usual in March. The NWM Primary Mortgage and the NWM Balanced Mortgage Funds returned 0.5% and 0.6% respectively. Current yields, which are what the funds would return if all mortgages presently in the fund were held to maturity and all interest and principal were repaid, are 4.4% for the Primary Fund and 6.8% for the Balanced Mortgage.
Preferred shares were down slightly in April with the NWM Preferred Share losing 0.3%. Volatility in the preferred share market increased as rate resets fell over 1% for the month.
The whole preferred share market in April was bifurcated as interest rate sentiment and further rate reset ETF dynamics drove the market in separate directions. As a result, rate resets significantly underperformed both floaters and perpetuals.
The NWM Preferred Share Fund was able to mitigate some of the overall market losses with active positions and trading. The market will probably pare some losses, but overall volatility may remain for a few months as market participants drive up demand for passive ETFs and facilitate large trading volume in certain segments of the market.
Canadian equities were down in April with the S&P/TSX losing 2.1% (total return, including dividends), while the Strategic Income Fund decreased 0.8%. The Tactical High Income C$ gained 1.1%.
In the Strategic Income Fund (SIF), we established a position in Canexus and added to our Dollarama, Saputo, and Shoppers Drug Mart positions using proceeds from the sale of our holdings in Tim Horton’s. It’s no longer “Time for Tim’s.”
Foreign equities were mainly higher in April with only Edgepoint and Templeton Smaller Companies losing ground, down 0.7% and 0.1% respectively. The NWM Global Equity Fund gained 1.8% while the MSCI All World Index was up 2.1%.
Cundill again led the way last month with a 3.7% increase, while Guardian Asia Growth and Income returned 2.7%.
The NWM Tactical High Income US Fund (which is not part of the NWM Global Equity Fund) was up 0.9% with the S&P 500 increasing 1.9%. The Tactical U.S. Fund ended the month with 32% cash, which should be invested in May with potential new names coming from the health care, consumer staples, and financial sectors.
Real estate outperformed the Canadian equity markets with the NWM Real Estate Fund up 3.6%. Everyone likes yields in this market.
Alternative strategy funds were weaker in April. Gold bullion was down nearly $140 an ounce in Canadian dollar terms (-8.5%), but gold stocks declined more, with the NWM Precious Metals Fund down 16.6%. The Alternative Strategy Fund was down 0.1%.
April in Review
It was a mixed month for capital markets in April, with both the S&P 500 and Dow Jones Industrial Average advancing 1.9%, while the S&P/TSX continued to lose ground, falling 2.1%.
For U.S. equity investors, it’s been almost 6 months since the Dow has suffered a 5% decline and 87 days (as of early May) since the Dow fell 3 days in a row, its longest such winning streak since 1958.
Since bottoming in March 2009, in fact, the Dow is up a startling 130%, tacking on over 7,000 points in just over 1,000 trading days.
Leading U.S. equity markets higher again last month were traditionally defensive sectors, such as staples, utilities, and healthcare. An appetite for yield and an aversion to risk is what is driving stocks higher as investors are not convinced the economic recovery is unfolding as planned.
Tax increases in the U.S., and what is turning into a 1930s style depression in Europe, has put pressure on corporate earnings and has investors erring on the side of caution. As a result, the prices of low growth companies, such as utilities, are getting bid higher, while more cyclical sectors, such as technology, continue to languish.
With certain tech companies able to deliver double digit earning growth while trading below a market multiple, investors are pricing in a steep penalty for risk.
If the U.S. economy continues to recover, which we think it will, companies will begin to spend again, and sectors such as technology and industrials will start to outperform.
Investors should start to re-position portfolios accordingly.
Some are even shorting Canadian securities, with speculators in early May net-short the Canadian dollar to the tune of $6.7-billion, with the exception of the Japanese Yen, the largest short position for any major currency.
Short positions against Canadian equities have also risen 11% versus a mere 3% increase in U.S. equities. So far, Canada has largely managed to defy the bears as the Canadian dollar has declined a mere 1% this year. Where the bears have been more successful, however, has been shorting commodities, particularly gold.
We have to admit, we were surprised with the price action in April and offer 3 theories for the negative sentiment.
1. Gold is traditionally thought of as a hedge against inflation. We believe negative real interest rates are the true driver for higher gold prices, but we understand the theory. Unfortunately for gold bugs, inflation is nowhere to be seen. In fact, deflation is again a greater concern.
2. Gold is seen as a hedge against U.S. dollar weakness. Given the state of the global economy and the relative strength of the U.S. economy, the U.S. dollar isn’t looking so bad.
3. Gold is supposed to protect investors against the decline in purchasing power of fiat currencies, except it continues to slump despite aggressive money printing by the Federal Reserve and the Bank of Japan.
Also adding fuel to the negative sentiment fire were rumours Cyprus might be forced to sell their gold reserves (apparently untrue) and Goldman Sachs was advising clients (and the world) to short gold (apparently very true). All these factors have many investors wondering, what role does gold play in their investment portfolios?
We still like gold for the longer term, but we concede gold is lacking a short-term catalyst. If the U.S. economy continues to strengthen, interest rates will start to move higher. If this results in real interest rates turning positive, this is bad news for gold.
Only if inflation increases faster than nominal interest (nominal interest rates – inflation = real interest rates) is the allure of gold maintained. We think this is the Fed’s plan but it might take a few months/years to play out.
As a side note, we would point out that central bank demand for gold is still strong, with China stepping up to the plate in April and importing a record 182 tonnes. Also, demand for gold coins remains very strong.
So what should investors do now? We believe an allocation to gold provides a form of portfolio insurance against a loss of purchasing power in fiat currencies. It is also a great portfolio diversifier, as it has a low or even negative correlation to other asset classes.
For those that have already bought their allocation, we would hold it. For those that are looking to make an allocation, we would buy it now.
Say what you want about Canada and gold, but in our books Europe is where the shorts should be hanging out. In fact, many commentators are now starting to use the “D” word (depression) when describing the Euro-zone economy given GDP is still 3% below early 2008 levels, and falling.
While the problems in the periphery countries (Greece, Spain, Italy, Portugal, Ireland, and now Cyprus) make most of the headlines, now even the core of Europe is starting to crack.
Finland recently reported a year-over-year decline in industrial production of 7.5% (would you consider buying a Nokia cellphone?), while Austria is threatened by economic turmoil in Slovenia (next up in the bailout queue?) and Hungary.
The Netherlands is dealing with a housing crash while France hopes the bond markets don’t wake up to the fact that the French economy is stagnant and reforms have stalled. Government spending comprises 56% of French GDP.
What are they thinking? Even Germany is starting to wilt, with GDP expected to grow only 0.3% in 2013.
President of the Bundesbank, Jens Weidmann warned recently the crisis in the Eurozone could last a decade, while German Finance Minister Wolfgang Schauble was quoted as saying “no one should think Europe will deliver high growth rates in the coming years.”
We respect their candor and honesty, but they are central bankers. Honesty is not in their job description! Making matters even worse, inflation in the Eurozone continues to fall, hitting 1.2% in April versus 1.7% in March and 2.6% just last September.
Nowhere is the economic crisis in Europe more evident or more pressing than the job market, with the unemployment rate for the 17-country Eurozone hitting a record 12.1% in March and leaving 19.2 million people looking for work.
The youth unemployment rate was 24%. In Spain, the unemployment rate hit 27.2%, the highest rate since at least 1976, a year after notorious dictator Francisco Franco’s death. Good times.
The good news is the youth unemployment rate was unchanged from February. The bad news: February’s youth unemployment rate in Spain was a horrific 55.9%. Yes, Germany’s unemployment rate is holding steady at 5.4%, but the rest of Europe is getting laid off.
So what are Eurozone leaders going to do? Well, the first step in the central bank playbook is to cut interest rates, which the ECB did on May 1 by lowering overnight lending rates by 0.25% to 0.50%. President Mario Draghi also pledged that the ECB “stands ready to act if needed,” meaning further cuts maybe in the cards.
Of course they can only cut rates to zero, and high interest rates are not Europe’s problem. So on to Step 2 in the playbook, which is more stimulative fiscal policy, or in Europe’s case, less fiscal austerity.
While Germany is putting on a brave face, even the Germans know deadlines on budget deficit targets are going to slip as the social cost of austerity is becoming politically unpalatable.
What is Step 3? Quantitative easing and money printing, as being conducted by the Federal Reserve and now the Bank of Japan.
While Germany has been firmly against this, it should be pointed out that Germany’s biggest export competitor is Japan, and the yen is plummeting as a result quantitative easing, making Japanese exports very competitive with German exports.
Exports are the life blood of German economic growth and employment, and if the German economy starts to contract, look for them to get into the money printing business.
Of course, the Eurozone isn’t the only country cutting interest rates. On May 7, the Australian central bank cut interest rates to a record-low 2.75% as the Australian dollar continued to hover around 30-year highs, despite a slowing domestic economy.
A day later, New Zealand’s central bank intervened in the foreign exchange markets in order to contain the rise in the New Zealand dollar, while Thailand, the Philippines, and China contemplate moves to do the same. Not to be left out, on May 9, the Bank of (South) Korea cut their base rate 25 basis points to 2.5%.
Can you say global currency war? It seems Canada stands alone with its hawkish monetary policy. And hedge funds want to short our dollar and sell gold?
The U.S. Economy
First quarter GDP grew 2.5%, well below expectations of 3.2% growth. On the positive side, consumer spending was the largest contributor to growth, increasing 3.2% and accounting for 2.24% of the economy’s 2.5% growth rate.
Inventory rebuilding added just over 1%, while residential fixed investment (think home building and household improvements) increased 12.6% and contributed about 0.31% to GDP growth.
Detracting from growth was a 4.1% decline in public-sector spending and a 5.4% increase in imports. Combined, these 2 categories shaved 1.7% off GDP growth. Backing up the weakness in GDP was a decline in most manufacturing indices. Industrial production managed to increase, but mainly on the back of increased utility demand due to cold weather.
While the U.S. economy has managed to expand 15 straight quarters, the average growth over this time period was just over 2%. No post-WWII recovery has posted less than a 2.5% annual growth in GDP.
The IMF estimates growth for the full year will come in at only 1.9% with the sequester (spending cuts) subtracting about 0.50% from last year’s growth rate. This would be better than Europe, but less than the emerging market economies.
The one country where the IMF has become more optimistic is Japan, increasing 2013 growth estimates by half a percent to 1.6%.
April’s employment report delivered a better-than-expected increase of 165,000 jobs, with underlying growth potentially even stronger than headlines suggest. February and March’s figures were revised 114,000 higher, following a recent trend of upward revisions.
A continuation of this trend could result in April’s total also being revised higher. In addition, UBS economists believe the shorter-than-normal time gap between the release of the March and April surveys could have depressed April’s totals by 60,000 jobs.
The unemployment rate fell to its lowest level since December 2008, and in early May, jobless claims hit their lowest level since November 2007. All the gains were in the private sector with professional and business-services jobs leading the way with 73,000 new jobs, while the government sector lost 11,000.
The only negative the bears had to point to was a slight decline in hours worked, which was most likely due to cold weather as the Labor Department reported 329,000 people were forced to work part time due to weather, a 6-year high for this time of year.
The manufacturing sector, in fact, is increasing hours worked to levels last seen in the economic boom years of the early 1990s as businesses struggle to keep up with a sudden increase in orders. Temporary jobs increased 31,000 in April, also an indicator of future hiring.
Inflation continued to move lower in March, giving the Federal Reserve a free hand to continue buying bonds and printing money (quantitative easing) with reckless abandon. The Federal Reserve will talk about easing monetary policy, but for now, that’s all they will do.
It was a split decision for consumer confidence in April with the Conference Board Indicator up, while the University of Michigan Index was down slightly. We wouldn’t read too much into either this month.
The U of M index was down from the previous month, but momentum was building during the month as the final reading exceeded the mid-month estimate. The Conference Board Indicator increase was almost entirely due to an increase in expectations as the assessment of current conditions pointed to a little weakness. Let’s call it even.
Retail sales were weak in March, and while same-store sales were higher in April, the late Easter probably stole a little from March’s totals and added to April’s. Combining these 2 months together, sales probably grew an average of about 2%, which is about on par with recent trends.
While weather contributed to the weak sales numbers, the payroll tax increase at the beginning of the year is likely starting to weigh on consumers. Top line retail sales figures are also being constrained by lower gasoline prices, which in turn helps increase disposable income.
In fact, it is estimated lower gas prices could add about $45-billion to consumer pocketbooks in 2013, offsetting about 40% of the estimated $115-billion hit from the increase in the payroll tax.
The housing market continues to recover with both existing and new home sales increasing. Prices have increased steadily and are up around 10% from last year. Some hard hit markets have rebounded more strongly, with Phoenix up 23% and San Francisco 18.9%.
Even with these gains, low mortgage rates have helped make buying a home more affordable than at any time in the past 30 years. Nationally, prices would need to rise 32% for affordability to return to its long-term average.
Rising prices make many potential sellers reluctant to list their homes for sale, especially as prices still remain well off their highs. As a result, it has become a seller’s market with buyer’s scrambling over what little inventory becomes available. In March, 37% of homes sold had been on the market for less than a month and 50% sold within 2 months.
This is good news for builders, who are starting to ramp up construction. In March, there were an annualized 417,000 new homes sold, almost 20% more than last year’s tally. Peak new home sales, however, hit an annualized 1.4 million in July 2005, so there is plenty of room left to grow.
The trade deficit narrowed more than expected in March as imports registered their biggest drop since 2009. The U.S. trade deficit with China fell to its lowest level in 2 years while imports of crude oil averaged just 7 million barrels a day, lowest since March 1996.
It’s slow going, but the U.S. continues to show signs of recovery. As long as the payroll tax increase and sequestration spending cuts don’t take a bigger bite out of growth than expected, the U.S. economy should remain the World’s “least dirty shirt” and the dollar should continue to appreciate.
The Canadian Economy
Canadian GDP again grew more than expected in February, as manufacturing output and resource sector strength more-than-compensated for weakness in the accommodation and food services sector. Estimates for Q1 GDP moved up to the 2% level, still quite modest, but an improvement from previous estimates.
Canada’s job market in April bounced back from March’s poor results, but still came in lower than estimated. In addition, the private sector actually shed 20,000 jobs as 34,200 government jobs were added.
The unemployment rate was unchanged at 7.2%, but the youth unemployment rate (15-24 years of age) increased to 14.5% versus 14.2% last month. On the positive side, hourly wages increased 2.8% year-over-year versus 2.1% last month.
Inflation continues to trend lower, leaving plenty of room for more monetary stimulus if needed. We certainly don’t see interest rates moving higher any time soon.
Retail sales continued to trend lower in February. A slowing housing market and stagnant job market should keep consumers in check. Consumer debt-to-household income looks to have finally peaked and should also help keep retail spending flat.
Even Vancouver looks to be improving sequentially, with sales in April up nearly 12% versus March, though still more than 6% lower than last year’s levels. Prices appear to be following a similar pattern, with modest increases over the past few months.
Canada’s trade balance in March moved back into surplus territory for the first time in over a year led by a broad based increase in exports.
We see the risk to the Canadian economy from a collapse in the housing market, but we disagree with hedge funds shorting Canada. We continue to think the Canadian housing market is different than the U.S. market and a soft landing is still the most likely outcome. Canada should also benefit from an improving U.S. economy.