Highlights This Month
- Is Europe experiencing a financial renaissance?
- The potential fallout with Greece’s dangerous game
- China’s economy is weak — so why are equities on the rise?
- Our current predictions for the U.S. economy
- Finally some good news for wage growth…
- Could inflation be quietly on the uptick?
- 7 years post-bust: can we expect a housing market boom?
- Why a soft U.S. economy will be good for growth
- A big picture look at the Canadian economy
- January retail sales show consumer caution
The NWM Portfolio
The 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. Returns for the Core Portfolio decreased 0.3% for the month of March.
The preferred share market was down in March with the BMO S&P/TSX Laddered Preferred Share Index ETF returning -0.5% while NWM Preferred Share was down -0.7%. After bottoming in 2014, interest rate volatility has picked up and continued to move higher in March.
We saw the Government of Canada 5-year touch 1% before moving down to 0.72% during the month. Sentiment continues to be challenged in the space; however, we are seeing preferred shares with more attractive reset spreads coming to market.
Canadian equities were weaker in March with the S&P/TSX down 1.9% (total return, including dividends), while NWM Canadian Equity Income (Former Strategic Income Fund) was down 0.3% and the NWM Canadian Tactical High Income was flat. The cash position in NWM Canadian Equity Income is currently about 4.0% and approximately 8% of our positions are covered.
We added new positions in Restaurant Brands and Auto Canada. As for NWM Canadian Tactical High Income, we added new positions in Restaurant Brands International and First Service Corporation. We also added to existing positions in Gluskin Sheff, Ag Growth, and KP Tissue and were called away on our Cineplex position and partially called away on Transforce.
Foreign equities were positive in March with NWM Global Equity up 0.6% versus the MSCI All World Index which was down 0.2% and the S&P 500 (in Canadian dollar terms) which was down 0.3%.
Of our external managers, all were in positive territory except for Mackenzie Cundill Value, which was down 2.7%. Edgepoint was up 2.0%, Templeton Global Smaller Companies was up 1.3%, BMO Asia Growth and Income Fund was up 1.0%, and Pier 21 Carnegie was up 0.6%.
NWM U.S. Equity Income was down 1.4% in U.S. dollar terms and NWM U.S. Tactical High Income was down 1.1% versus a 1.6% decrease in the S&P 500. For NWM U.S. Equity Income, we added new positions in Synchrony Financial and Accenture while trimming Intel, GE, and Boeing. The fund has a cash position of 5.4% and 10% of the fund is covered. As for the U.S. Tactical Fund, we were called away on our Boeing position and have not repurchased.
The REIT market remains firm with NWM Real Estate increasing 0.2% in March.
The mortgage pools continued to deliver consistent returns, with NWM Primary Mortgage and NWM Balanced Mortgage returning 0.3% and 0.5% respectively in March, as they did in February.
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 and in no way is a predictor of future performance, are 4.1% for the Primary Mortgage, or 4.4% if fully invested, and 5.6% for the Balanced Mortgage, or 6.2% if fully invested.
NWM Primary Mortgage had 7.6% in cash at month end, while the Balanced Mortgage had 15.6% in cash.
Interest rates moved marginally higher during the month, and as a result, so did the NWM Bond in March. 2-year Canada yields increased from 0.47% at the beginning of the month to 0.51% at the end of the month, while 10-year Canada’s increased from 1.30% to 1.36%. NWM Bond increased 0.1%. PH&N’s short term Bond Fund was unchanged, as was the Marret Investment Grade Hedged Strategies Fund. Arrow East Coast was up 0.3% while PR Fixed Income Plus was down 0.1%.
High yield bonds fared a little better, with NWM High Yield Bond up 0.7%.
Global bonds were weaker again last month, with NWM Global Bond down 0.2%, despite the Canadian dollar being down 1.4%. Year to date, the Global Bond Fund is up 6.5%.
The NWM Alternative Strategies was up 0.9% in March (these are estimates and can’t be confirmed until later in the month). Altegris feeder funds Winton, Brevan Howard, Millennium and Hayman were all positive, increasing 3.2%, 1.8%, 4.4% and 0.4% respectively. SW8 was down a disappointing 11.7% while RP Debt Opportunities and MAM Global Absolute Return Private Pool were both up 0.6%.
NWM Precious Metals was down 7.1% in March with gold bullion down 1.1%.
March in Review
March brought further evidence the U.S. economy has hit a soft spot.
Equity markets finally began to notice, with the S&P 500 falling 1.6% (in U.S. dollar terms) and the S&P/TSX falling a similar 1.9%.
Pick your poison. Retail sales, durable goods, employment, wage growth — all were disappointing and further suggest the U.S. economy has slowed. In fact, Citigroup’s Economic Surprise Index, which is a rolling tally of beats and misses relative to analyst estimates, recently hit three and a half year lows.
The glass half full crowd view the recent soft patch as largely weather related; they compare the past three months of severe winter weather and its impact on the economy to last year, when GDP contracted in Q1 only to record strong growth the following six months.
They also cite the west coast port strike (which has since been resolved), the strong U.S. dollar, and turmoil in the energy sector as contributing factors that should dissipate as the year progresses.
And the glass half empty crowd? Well, they were the ones selling, weren’t they?
Stocks have had a good run. Of the 26 bull markets experienced by investors over the past 85 years, the present bull market is the fourth oldest at just over 6 years and will take over the number three spot if we make it to early May without a 20% correction.
It’s also been one of the most profitable bull markets with cumulative gains of over 200% — more than twice the historical average.
Most of the gains of late can be attributed to higher valuations, however, as earnings growth has been challenged. Factset estimates Q1 S&P 500 earnings will be down 4.6% versus last year and total 2015 earnings are forecast to show a mere 2.5% gain.
Much of the blame is being directed towards the strong U.S. dollar, which is up over 20% versus a basket of major currencies, and predictably weak earnings from the oil patch.
While only about 14% of the U.S. economy as a whole is export related, S&P 500 companies on average derive about 46% of their sales from foreign buyers. Likewise, energy might not by a large component of the U.S. economy, or the S&P 500, but Factset is estimating earnings in the sector will crater 64% in the first quarter.
The only good thing one can say about the strong U.S. dollar is this: the resulting weak economy and earnings are likely to delay the Fed’s plan to raise interest rates.
While the Fed recently removed the word “patient” from its commentary regarding the timing of future interest rate increases, the strength of the dollar and weak economic numbers have trimmed the odds of the Fed increasing interest rates in September to 28% — with odds of the first increase taking place in June all but off the table.
As a result, the U.S. dollar has taken a bit of a breather. Investors are advised not to hold their breath, however; things can change fast and a string of good economic numbers could persuade the Fed to have even less patience.
The Stoxx Europe 600 Index increased 1.8% in local currency terms in March and is up nearly 17% in 2015 with Factset reporting valuations reaching a U.S. style 16.6 times next 12 month earnings.
Admittedly, it’s been a tough slog with the Stoxx Index only recently back to levels hit some 15 years ago and company earnings on the Stoxx still 26% below their pre-financial crisis peak.
The Eurozone economy is showing some life, however, with Markit’s purchasing manager Index hitting a four year high of 54.1 in March after increasing for the fourth month in a row.
In addition, the OECD recently increased Eurozone GDP growth forecasts to 1.4% in 2015 and 2.0% in 2016.
With question marks surrounding U.S. markets and bond yields in Europe insanely expensive, Eurozone stocks appear the lesser of several evils.
Also helping European corporate earnings is a falling Euro, which makes exports more competitive.
Since last June, the Euro is down more than 20% against the dollar — and according to a recent Societe Generale survey, most traders and investors believe the Euro is on its way to parity against the greenback.
Goldman Sachs, in fact, believes the Euro will hit $0.80 by late 2017, despite conceding fair value is probably closer to $1.20. Goldman believes U.S. monetary policy will dictate the Euro’s direction, as higher U.S. interest rates will help drive capital out of Europe and into American dollars.
Even with the dramatic sell off, the Euro is only back to pre-crisis levels. Of course if they are wrong and the Federal Reserve doesn’t increase interest rates, the current Euro weakness could be overdone.
More importantly for investors, however, past declines in the Euro haven’t necessarily translated into stronger export growth, an experience shared by Japan in the late 1990’s.
In fact, Stanford University’s Edward Lazear believes currency isn’t a major determinant of trade, and ranks it a distance fourth behind geographical distance, income of importing countries, and productivity of exporting countries.
In other words, if you’re buying European stocks at these levels, it better be for reasons other than the currency is weak.
Didn’t Greek Finance Minister Yanis Varoufakis in early March describe his own country as the most bankrupt nation in the world and claim European leaders have known all along that Greece would never be able to meet their financial obligations?
Isn’t it true Greek Deputy Finance Minister Dimitris Mardas belligerently claimed recently that Germany owed Greece €278.7 billion in compensation for damages incurred during World War II?
Regrettably, all true.
The ruling Syriza party is playing a dangerous game of brinkmanship that could result in Greece defaulting and effectively leaving the Eurozone. The good news, however, is that most Greek debt is owed to governments that are in a better position to deal with a default.
In addition, bond market contagion is likely to be minimal given the Eurozone’s current quantitative easing program means any frightened bond investors can find an eager buyer in the form of their local Eurozone central bank.
A worse outcome might be letting Syriza get their way, resulting in reforms being rolled back and providing a roadmap for anti-reform and austerity parties in other countries and dooming progress made in emerging success stories like Spain.
Europe may look the better buy in the short term, but make no mistake: structural problems with the Euro still exist. Buyer beware.
At least with Europe, we understand why stocks are moving up.
Stronger economy (at the margin) and weaker currency all help make the case corporate earnings could be on the rise.
Last month the Shanghai Composite increased over 13% in local currency, and is up almost 16% year to date. It can’t due to a weak currency because the Chinese yuan is effectively pegged to the U.S. dollar (along with a basket of other currencies) and has been appreciating along with the U.S. dollar.
Also unlike Europe, the Chinese economy is looking weaker, not stronger. Industrial production in January and February grew a scant 6.8% versus the previous year, the slowest growth since recession plagued December 2008.
Retail sales increased only 10.7%, which may sound good, but is downright stagnant for China and is the slowest retail sales have grown in a decade.
And finally, the HSBC Purchasing Managers Index fell to 49.2 in March — below 50 and thus indicating the manufacturing sector in China is contracting.
In fact, the only thing good one can say about the Chinese economy is that it is so weak many feel Beijing will feel compelled to look at a new stimulus program — either interest rate cuts, reductions in bank reserves, or all of the above.
The motivation for the recent move in stock prices, however, might be a little light on fundamentals, as retail investors appear to be the main force driving the market higher.
According to China’s main clearing house, more than 4.8 million new trading accounts were opened in March, with an additional 1 million added in the first two days of April alone.
Margin loans in Shanghai and Shenzhen are up 250% over the past six months, and stocks, which were trading at only 7.5 times forward earnings last summer, are now valued at around twice that level today.
We suspect this will not end well.
Japanese stocks were also higher in March, with the Nikkei 225 increasing 2.7% in local currency terms.
You get the idea. Traders believe the U.S. rally is done and it’s time to look for new opportunities.
We concede that the U.S. economy has disappointed so far this year and the strong rally in the U.S. dollar could become problematic for growth going forward — but we still believe it’s too soon to shift away from U.S. assets.
While U.S. economic growth won’t set any records, we expect it will follow a similar pattern to last year and improve as the year progresses.
We do, however, reserve the right to change our mind next month.
The U.S. Economy
Economic indicators in March continue to suggest U.S. economic growth got off to a sluggish start in 2015.
Durable goods orders declined 1.4% in February and the Institute for Supply Management Purchasing Manager’s Index declined for the fifth month in a row in March to its lowest level since May 2013.
Economists responding to a WSJ survey believe first quarter GDP will grow only 2.3%, barely above Q4 2014’s disappointing 2.2% growth rate. The economists surveyed, however, believe the U.S. will recover in the spring and record growth of 2.9% for the year in total.
The main assumption these forecasters are making is that like last year, severe winter weather is responsible for the bulk of the slowdown in Q1 and growth will return in the spring.
Despite having more money to spend as a result of lower gasoline prices, consumers spent less and saved more in February — which many suspect is due to a reluctance to venture outside rather than a new found desire to become more financially responsible.
On the other hand, the strong U.S. dollar is hurting export growth with net trade estimated to have shaved 1.2% off Q4 GDP growth and likely to detract an additional 0.6% off Q1 growth.
Capital spending is also likely to decline as activity in the oil patch continues to slow.
J.P. Morgan expects lower energy capital expenditures could detract 0.3% off GDP growth in 2015. The good news is they also believe the increased disposable income that should accrue to consumers from lower gasoline prices should add 1.0% to GDP growth.
Lots of moving parts, and a bit of a timing mismatch, but the U.S. economy should be just fine.
If there was any doubt the U.S. economy slowed in the first quarter, they were eliminated by employment data in March which showed only 126,000 net new jobs created — the lowest since December 2013.
This is the first time since last August the U.S. has generated less than 200,000 jobs and was well below economist expectations of 248,000.
Bond traders were happy, however, as the odds of a June increase in the Federal Funds rate plummeted.
Like GDP growth, however, poor weather likely played a role and there continues to be signs the job market in the U.S. is tightening — and wage growth could finally be just around the corner.
The unemployment rate for workers who have been out of work for less than six months has fallen below 4%, a level historically considered on the inflation threshold.
Companies are starting to feel the pressure and indicating plans to raise wages over the coming months.
Inflation continues to move lower — not just in the U.S., but globally. The recent strength of the U.S. dollar is likely to put further downward pressure on prices as imports become cheaper.
This assumes, of course, retailers choose to pass on the savings to consumers rather than padding their own profit margins.
A sharp increase in the PriceStats Index could be merely capturing a slightly higher gasoline price last month, though even “ex-gas” prices look to be rebounding.
This is definitely something to keep a close eye on, because no one is talking about an uptick in inflation.
Mixed consumer confidence numbers in March; both still continue to show strength, however.
As mentioned above, the consumer took a bit of a winter holiday in February as retail sales declined and the personal savings rate hit its highest level since the end of 2012. We suspect weather was the cause, and spending should warm up with the temperature.
We remain hopeful the housing market will see a better year in 2015.
Housing starts have gotten off to slow start, with February down 17% versus January levels and 3.3% lower than starts the same time last year.
Again, however, weather was likely the main culprit, as building permits, which are less weather sensitive, showing more strength. Sales of newly built single family homes were also strong, increasing nearly 8% to their highest level since February 2008.
We would expect demand to continue to pick up as household formation moves higher and renters look to become owners. Even former owners who lost their homes during the housing bust — estimated to top over five million families — could be looking to get back into the market.
It typically takes about seven years for foreclosed homeowners to repair their credit scores to the degree that they are eligible for another mortgage. Given the housing bust began in 2007, many foreclosed homeowners should become eligible for a new mortgages over the coming few years.
A big move down in the trade deficit in February.
Lower oil prices were a big driver, but the strong dollar also played a role in driving import prices lower. This positive net trade number could provide some much needed support to first quarter GDP growth.
How much is the current weakness due to the weather? Is the dollar having a negative impact on economic growth, and why are consumers not spending their oil fueled windfall?
We think the softness in the U.S. economy is temporary.
No one is expecting great things for growth in the first half of the year as the decline in the energy sector will likely result in a contraction for one of the few industries in Canada experiencing strong growth.
Weakness in the economy didn’t translate into weakness in the job market in March, as Canada added nearly 29,000 jobs. In fairness, the quality of the report was poor, as all the new jobs and then some were part time.
Canada actually lost over 28,000 full time positions in March. Nearly all the jobs were also public, or government, as over 19,000 private and 17,000 self-employed positions were lost.
Overall, not a bad month, but employment tends to be a lagging indicator and more weakness could be expected in future months.
Headline inflation was below the Bank of Canada’s 2% target due to lower gas prices, but core inflation remained above target for the seventh month in a row. The weak dollar remains a big contributor to the higher core inflation number.
Food prices continue to move up, increasing nearly 4% over the past 12 months, as have clothing and footwear, and reading materials. But don’t go crying in your beer, it was up it was up 4.4% year over year.
Not sure what consumers were so confident about in March, but they sure didn’t appear very confident in January according to retail sales data.
In fact, the combined sales decline for December and January was the largest since November and December of 2008.
Predictably, Alberta was ground zero with sales declining for a record four months in a row.
According to AutoCanada, some Calgary car dealers reported a decline in sales of up to 33% in January.
Lower gasoline prices helped depress retail sales, but the decline was generally broad based and fell in a majority of subsectors.
The Canadian economy might be taking a step back, but nothing can hold the housing market down.
In reality, Vancouver and Toronto continue to make the numbers look better than they are. Alberta remains a concern, with prices stable but lots of homes up for sale.
Canada’s trade deficit narrowed in February, mainly due to higher import prices as energy product prices increased nearly 18%.
A weak Canadian dollar and strong U.S. economy should be good for Canada’s balance of trade going forward.
What did you think of March’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.