- Are companies playing the “weather card” to deflect a slowdown?
- Defensive market strategies: value and dividend paying stocks
- Did the rookie Fed flub her first call?
- Why continue to own stocks?
- Is the crisis in Europe really over?
- The Chinese economy is still a concern.
- Wage growth is spurring the Federal Reserve’s monetary policy.
- What factors will propel inflation higher?
- Is the U.S. economy rebounding?
- U.S. housing permits go up, but housing starts stay weak.
- The Canadian economy gets a boost.
- Canadian home sales and prices hit record highs
The NWM Portfolio
Returns were positive across most asset classes in March, though only due to a rally at the end of the month.
Interest rates moved slightly higher again last month, with two-year Canada yields ending the month at 1.07% versus 1.00% at the start of the month. 10-year Canada’s backed up a similar amount, ending the month at 2.46% versus 2.43%.
NWM Bond was up 0.4% in March entirely due to our alternative managers, who have eliminated almost all interest rate exposure in their portfolios. For the first quarter, NWM Bond is up +1.5%.
High yield bond returns were also able to mitigate the negative interest rate move in March, as NWM High Yield Bond increased 0.6% and ended the quarter up 4.1%. Like equities, high yield bonds have had a strong run. A short-term correction could be expected.
Global bonds were also stronger, with NWM Global Bond increasing 0.8% and +4.7% for Q1.
Mortgages continue to deliver steady returns, with NWM Primary Mortgage and NWM Balanced Mortgage returning 0.3% and 0.8% respectively for March and +1.2% and +1.9% for the quarter.
NWM Preferred Share returned 1.25% for the month of March, outperforming the overall markets as the S&P/TSX Canadian Preferred Share Index ETF returned 0.77%. We have been opportunistically selling perpetual issues, and now the weight in the fund stands at 9%, less than a third of the perpetual weight in the S&P/TSX Preferred Share Index.
Both perpetuals and rate resets were well bid in the month as investors positioned themselves ahead of the squeeze on supply with an expected $5.8-billion in redemptions for resets coming later this year.
Canadian equities were strong in January with the S&P/TSX gaining 1.2% (total return, including dividends), while NWM Strategic Income was up 2.0% and NWM Canadian Tactical High Income was up 0.7%.
Foreign equities were mainly stronger in March, with NWM Global Equity up 0.2% versus 0.1% for the MSCI All World index, and 0.8% for the S&P 500 (all in Canadian dollars). All of the pool’s external managers were up in March, with the exception of the Templeton Smaller Company, which was down 1.0%.
The REIT market continues to recover, with NWM Real Estate up 0.8% in March and +3.4% in Q1.
NWM Alternative Strategies returned approximately -0.4% in March (this is an estimate and can’t be confirmed until later in the month), while gold gave back some of its strong gains with gold bullion declining -3.3% in March and NWM Precious Metals -4.8%. Year-to-date, NWM Precious Metals is up +23.0%.
March in Review
Markets generally grinded higher during March with the S&P/TSX up 1.2% and the S&P500 0.8% higher (in Canadian dollar terms), but it was a tough slog. Winter has taken a toll, both from a general morale perspective, as well as from a real economic impact point of view.
According to Factset, company conference calls discussing fourth quarter earnings held between January 1 and March 12, mentioned the word “weather” at least once in 195 calls. This is an increase of 81% over last year, when only 108 companies discussed weather in their earning conference calls.
Clearly the weather was remarkably poor this winter and it is reasonable to believe it contributed to a slowdown in certain sectors of the economy. In fact, the Citigroup Economic Surprise Index fell to its lowest level since 2011 as recent economic data has performed worse than expected.
However, playing the “weather” card can be a convenient excuse for companies and is commonly used by corporate executives to divert attention away from weakening fundamentals. Weather played a role, but it is likely not the only factor behind the slowdown.
In fact, investors have shifted away from growth stocks in favour of value names, which tend to outperform when the economic growth is strong.
Value stocks tend to be cheaper, and if the growing economy means most companies should be expanding their bottom lines, why pay more for growth stocks? Also doing well were dividend paying stocks, which have also lagged the market for the past couple of years.
Dividend and value are also seen as defensive strategies relative to the momentum-fuelled rally experienced in sectors like technology and biotech.
Of course, there is a less optimistic explanation for the shift from growth stocks to value stocks. Because growth stocks trade at high valuations and discount earnings far into the future, an increase in interest rates has a greater impact on the present value of those earnings.
Put another way, growth stocks are more interest rate sensitive (they have a higher duration).
Rookie Fed Chairwoman, Janet Yellen, held her first post-Fed meeting press conference in mid-March, and in many traders’ opinions, blew it.
When asked how long after the Fed had finished tapering would they begin actually raising rates, Yellen threw out a specific time period of six months. Seems reasonable, but in quickly flipping their calendars, traders realized that the mid-2015 time frame was earlier than the market previously thought.
Not surprisingly, 10-year bond yields quickly traded higher, while stocks went in the opposite direction.
In reality, Yellen’s disclosure wasn’t that material. Everyone knows rates will eventually go up and a few months either way won’t make much of a difference. If anything, the Chairwoman helped the market by making economic policy much more transparent in the future.
The problem is that it makes the market face an issue that it was hoping to put off as long as possible, namely, how it will deal with higher interest rates.
The overall market has been moving higher, despite the fact that the yield curve has been flattening, with shorter rates increasing in anticipation of Federal Reserve tightening. A divergence such as this tends to not last long.
Using the Shiller cyclically-adjusted price-earnings multiple (rolling 10-year average earnings), the market is trading at over 25-time earnings. Historically, when the market has traded at these levels, it has delivered an average compound loss of 1.4% over the following 10 years.
The problem for investors, however, is every asset class looks expensive. High yield bonds, for example, have also performed well and are currently trading at very tight spreads to government bonds. Also, it’s very tough to time the market.
In its recent 2014 Guide to Retirement, JP Morgan Asset Management illustrated the dramatic negative impact on returns investors would have suffered if they were out of the market for just 10 of the best performance days over the past 10 years.
Instead of a 9.22% return, they would have only got 5.49%. Miss the best 30% and returns plummet to less than 1%.
It’s a tough market to predict and diversification is an investor’s best friend when it comes to achieving good risk adjusted returns. Besides, we still think interest rates will stay low longer than most people think.
In combination with a recovering U.S. economy, equities should continue to grind higher. There may be a day of reckoning in the future, we just don’t think it’s going to be this year.
The immediate crisis in Europe appears to be over. The Euro-zone Purchasing Manager Index came in at 53.2 in March, well above 50, thus indicating the manufacturing sector is expanding.
Consumer confidence is at its highest level since November 2007, and consensus estimates for GDP growth are 1.2% for this year and 1.5% for 2015. The Euro appears to have survived, for now, with bond yields in the peripheral southern Euro-zone countries declining back to pre-crisis levels.
Greece is actually laying plans to come to the market with a new bond issue, rumoured to be $2.7-billion for five years. Greece is obviously banking on the fact investors have short memories, given the nearly 70% haircut holders of Greek debt took during the financial crisis.
With bonds and equities rallying over the past year (on the belief that the worst of the crisis is over) and the economy finally showing signs of bottoming, why the weak returns in March? Blame inflation, or more precisely, the lack thereof.
Like the U.S., the ECB targets a 2% inflation rate, but at 0.5% in March, current price increases are falling well short of the mark. While normally this would be good news, low inflation could make it harder for European countries to manage their stretched government debt loads.
In fact, potential deflation is cited by some as one of the reasons investors are willing to invest in Euro-zone government bonds, despite the dramatic decline in yields. While nominal yields look low, real yields are fairly competitive and could become even more so if inflation continues to decline.
Also, the fact that nominal interest rates are still higher than in the U.S. or Japan has resulted in the Euro strengthening, further dampening inflation.
Prices are still cheap in Europe and thus attractive to investors, given the belief that the Euro crisis is over, but reforms are needed to ensure the long-term survival of the Euro. This story is far from over.
In February, Chinese industrial production posted its weakest growth since 2009, while fixed asset investment increased at its slowest pace since 2002.
Retail sales also decelerated to levels not seen since February 2011. Backing up these stats was the HSBC purchasing Managers Index which hit an eight-month low of 48.1, below 50, thus well into contraction territory.
China has targeted GDP to grow 7.5% in 2014 and probably needs at least 7.2% in order to generate the 10 million new jobs needed this year. Based on current trends, some analysts suggest first quarter GDP growth will be only 7%.
Of course, China has a number of levers they can pull in order to drive growth higher. Their favourite of late has been investment spending, and China’s State Council recently announced a number of new spending initiatives to help bolster the economy.
Some observers also fear China might try to stimulate the economy by depreciating the Yuan, thus giving Chinese companies a leg up on their global competitors.
The problem with these initiatives, however, is that China is actually trying to re-balance its economy and wean itself off investment and export orientated GDP growth in favour of consumption led growth.
The consumer comprises a mere 35% of the Chinese economy compared to about 70% of U.S. GDP. China also recognizes it is getting less economic bang for its investment spending buck given credit growth has increased sharply over the past few years, while GDP growth has declined.
The IMF argues China has been over-investing in real estate and industrial capacity to the tune of between 12% and 20% of GDP, and it is likely at least some of these funds have been wasted.
The U.S. economy continues to look like the pick of the litter. We don’t see any other country leading the global economy out of recession. Let’s hope the U.S. winter-induced slowdown will soon give way to Spring.
The U.S. Economy
Fourth quarter 2013 GDP was revised higher, though slightly below analyst estimates, and still well below third quarter growth of 4.1%.
Most of the positive revision came from consumer spending, which grew 3.3% versus previous estimates of 2.6% and 2% in the third quarter. This is the fastest rate of growth for the consumer since 2010.
Economic growth is likely to decelerate in the first few months of the year with Macroeconomic Advisers estimating GDP growth of 1.5% in Q1 before recovering back towards the 3% growth level the rest of the year.
Manufacturing indices appear to confirm this, as all were firmly in expansion territory.
The unemployment rate was unchanged at 6.7%, but the participation rate increased slightly to 63.2% as more workers re-entered the workforce.
March actually marked a milestone for the labour market as private sector payrolls hit a record 116.09 million, finally surpassing the previous peak of 115.98 million set in January 2008.
It took over six years, but the U.S. has finally recovered the 8.8 million jobs lost during The Great Recession. Hold the champagne, though. The labour force has added about 2 million workers to its ranks over the past six years, leaving much work left to be done.
Also, of the 10.5 million workers currently without jobs, about 3.7 million have been out of work for more than 25 weeks. Many of these are likely to eventually drop out of the workforce, further depressing the civilian labour force participation rate, which, despite moving higher in March, is presently sitting near a 35-year low.
The U.S. Federal Reserve would desperately like to see the long-term unemployed get jobs. It would also like to see the estimated 7.2 million workers, who have part-time jobs (but would rather be working full time), find more work. There are signs, however, that the labour market is actually tighter than it looks.
Temporary job levels have been steadily rising, which is usually considered to be a bullish sign for the job market, as companies typically hire temp workers first coming out of a recession before making them permanent.
Also, average hours worked moved higher in March, and hours worked in the manufacturing sector actually hit its highest level since 1950.
According to the National Federation of Independent Business, more companies are citing quality of labour as their single most important problem as employers find it more difficult to find workers with the skills they need.
In fact, the short-term unemployment rate, which comprises workers who have been unemployed for less than 25 weeks, is currently only 4.2%, well below the 4.6% level the NY Federal Reserve estimates to be full employment.
While wage inflation moved down slightly in March, wage growth has been stronger the past several months, and is one of the factors giving the Federal Reserve confidence to continue normalizing monetary policy.
No sign of inflation again last month. The Bureau of Labor Statistics estimates drought in parts of the U.S. could drive retail food prices up 3.5% in 2014, which would be the biggest increase in three years.
The cold winter has also taken a toll, with the USDA forecasting fresh fruit prices will rise 2.5% to 3.5%. Along with wage inflation and higher medical costs, rising food prices should help inflation move gradually higher throughout the year.
Consumer confidence: steady as she goes.
Momentum could indeed be following through into Spring, with auto sales in March up nearly 6% as pent up demand is being slowly released.
Home sales, both new and existing, continue to ease, however prices remain firm. Low inventory levels remain below that of a balanced market, and at least partially explain the decline in sales. Let’s face it: prices are not the bargain they were a few years ago.
Private equity investors have been big buyers over the past two years, spending an estimated $20-billion for 200,000 rental homes. Many, like Blackstone Group, are starting to pull back.
We were encouraged by the nearly 8% increase in housing permits in February, as we believe new home construction will be one of the drivers behind stronger U.S. economic growth this year.
We have to admit, however, we are getting a little nervous as housing starts remain weak. We need to see those permits turn into construction.
The U.S. is doing its part to help global economic growth, but it’s not getting much help as exports fell 1.1% and resulted in a nearly 8% increase in the trade deficit. This does not bode well for GDP growth.
Overall, March was a good month, with the U.S. economy showing signs of emerging from its winter hibernation.
The Canadian Economy
Leading indicators and manufacturing indices in February and March point to continued growth, though more modest growth the rest of the first quarter is probably more realistic.
As with GDP growth, the job market rebounded strongly in March, with nearly 43,000 new workers finding employment. The quality was not great, however, as over 30,000 were part time, and 39,000 came from the public sector.
Headline and core inflation continued to move lower in February. This is a concern for the Bank of Canada and one of the reasons some suggest a rate cut may be in the cards.
We doubt this is the case and argue the lower Canadian dollar could help reignite inflation. We would also expect higher food prices will make their way north of the border.
Strong consumer confidence translated into solid retail sales in January, an obvious positive for the Canadian economy that was confirmed with January’s robust GDP growth.
While harsh winter conditions were likely a contributor, Canadian housing starts have been exceeding population growth for a while, so a pull-back is no surprise.
Canada’s balance of trade finally moved back into surplus territory in February as strong export growth, led by motor vehicles and parts and energy, outpaced import growth.
This bodes well for economic growth in February, and is evidence that a stronger U.S. economy will benefit Canadian pocket books. The Vancouver Port strike could temporarily impact growth in the near term, but we are hopeful exports will continue to benefit GDP growth over the next several quarters.
All in all, March was a pretty good month for the True North strong and free.
Let us know your thoughts on December’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.