Our Weekly Market Snapshot is brought to you by:

The Wealth Management Team, Capital Core Financial

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Week Ending: January 11th, 2019

Published: January 14th, 2019.

Highlights

It’s difficult to imagine more that could have happened in a month with so little change in the start and end points for equities. Since December 14, the S&P/TSX, MSCI Emerging Markets and MSCI EAFE Indices are all up between ~ 2% and 3% (yes – higher!) and the S&P 500 is only off -0.14%. If you’re a well-balanced investor and did not panic in December, you’ve been well served – you made some money over the last month, especially since the bond market handed out a 1% return in 18 trading days. Of course, in between has been a wild ride. The declines in equites and bond yields are being blamed on a variety of factors, many that linger and some we feel were transitory. At the top of the lingering concerns column sit recent sluggish global economic data, a weakening outlook for corporate earnings growth (especially in the U.S.), tightening financial conditions, trade tensions and Brexit. The transitory factors largely relate to the ‘perfect storm’ collision of the calendar, fund flows and panicked and programmed selling discussed in our Chart of the Week comments.

The biggest catalyst for equities in the coming weeks is the heart of the S&P 500 Q4 corporate earnings reporting season. Noise, uncertainty and volatility are set to continue with the U.S. government still shut down, and important Brexit votes happening almost daily and the deadline fast approaching. Our 2019 Outlook was already calling for just 5% earnings growth in North America, well below the consensus of late 2018 – a consensus that is quickly being ratcheted down. We’ve adjusted our earnings expectations down ever so slightly and are assigning lower equity valuation multiples because we see the fear of recession looming around every corner in 2019 – although we don’t believe the U.S. economy is quite there yet. The net result continues to drive 2019 North American equity price only returns in the high single digits. If we’re wrong, and 2019 does see an outright economic contraction, current equity levels are way too high and significant downside remains. This risk keeps us firmly aligned with a neutral asset mix recommendation between stocks and bonds. We acknowledge the temptation to trade during what might be a solid Q1 for stocks. We feel earnings will come in ‘less bad’ than expected, although the bounce thus far from December’s oversold conditions is removing much of this temptation quickly.

We see improvement on some of the known, but lingering issues. U.S.-China trade talks are progressing and central bankers (those who were tightening) are recognizing the impact of their actions thus far and are now pausing. We’re encouraged corporate credit spreads (i.e., investment grade, high yield and loans market) didn’t blow out to levels that would be expected given the equity market declines witnessed. The U.S. dollar actually weakened in December. Recall that U.S. dollar strength was a significant part of tightening global liquidity conditions. 

On the fixed income front, we still expect rates to rise in 2019 and for central banks to add further rate hikes later in the year – but we expect these will be among their last. We’ve lowered our year-end yield rate call for the Government of Canada 10-year from 2.40% to 2.25% and maintain our 2-year forecast at 2.25%. These assumptions drive a 0.5 to 1% total return for 2019, down from our December 7 view of between 1 and 2%.

 

Chart of the Week: Equity Markets Rebounding from Q4 Plunge

When the S&P 500 comes within a whisper of ‘bear market’ territory, it raises the question whether the -19.78% decline is a sign of a pending recession. While we feel the risks of a recession have risen, a 2019 recession is not our base-case scenario. It’s interesting to note the last three trading days before Christmas were broken by a weekend during which the S&P 500 declined 4.9%. Without those extra three days, the decline was only -15.8%; much closer to something we would expect given the mounting concerns and deteriorating fundamentals. We believe the outsized swings around Christmas were the result of extremely negative news flow combined with panicked and programmed selling that snowballed. Corroborating this view is the fact that U.S. mutual fund and ETF data show that December outflows were amongst the largest in history (only 2008 and 1987 were larger). Equity market declines outside of the U.S. were not as sharp, and all markets have since mounted a recovery.

 

The week in review

  • The Bank of Canada held policy rates steady at 1.75%, as widely expected. They updated some of their forecasts; notably anticipated growth for 2019 was revised down from 2.1% to 1.7%, but bumped up from 1.9% to 2.1% for 2020.

  • The U.S. government shutdown meant certain data releases scheduled for the week were postponed.

  • U.S. consumer prices (Dec.) fell 0.1% m/m (as expected), with the y/y rate falling to 1.9% from 2.2% previously. Core inflation held steady at 2.2% y/y.

  • Minutes from the December Federal Open Market Committee (FOMC) meeting indicated some policy makers felt the central bank could be more patient with future rate hikes.

  • U.S. ISM non-manufacturing PMI (Dec.) fell to 57.6 from 60.7 previously.

  • U.S. NFIB Small Business Optimism Index (Dec.) fell to 104.4 from 104.8 previously.

  • Mixed economic news out of the Eurozone. Industrial production fell 1.6%, 1.3%, 0.5% m/m in Italy, France and Germany respectively. Meanwhile, Eurozone retail sales tripled expectations with a 0.6% m/m rise in November; October’s increase was revised higher. Eurozone unemployment rate (Nov.) fell to 7.9%, from a downwardly-revised 8.0% level prior.

  • China took steps to promote lending and liquidity by cutting their banks’ reserve requirements by 1%. 

 

The week ahead

  • Canadian inflation data

  • Canadian and U.S. housing data

  • U.S. industrial production and retail sales

  • 35 S&P 500 companies report Q4 2018 earnings

  • U.K. parliament scheduled to vote on Brexit

Have a great week!

Your Wealth Management Resources Team at Capital Core Financial