Our Weekly Market Snapshot is brought to you by:
The Wealth Management Team, Capital Core Financial
Week Ending: December 7th, 2018
Published: December 10th, 2018.
Global equities slumped and bond yields fell sharply. Ostensibly, the past two weeks have seen two key events equity markets were thought to have wanted: a recognition by the Fed that their tightening campaign is having an impact, yet has limits; and, a cease-fire in the U.S.-China trade spat. The problem is capital markets are having trouble understanding either of these messages.
On trade, the message coming out of the Trump-Xi meeting was vague and uncoordinated, with notable discrepancies between the two sides accounts of the situation. The U.S. President clouds the situation by switching between “I am Tariff Man” and “China talks are going very well!” tweets. Tensions between the two global giants also concern national security issues, regional influence and technology supremacy. Adding an additional irritant to the already fragile relationship, Canadian authorities, acting on a U.S. warrant, arrested the CFO of Chinese tech giant Huawei for alleged violations of Iranian sanctions.
U.S. and Canadian central banks have quickly adopted a ‘dovish’ tone with bond yields taking the pivot to heart. Further pressures to bond yields include tepid inflation readings and decent, but not too hot, U.S. wage growth and outright sluggish wage growth in Canada. The yield curve in both countries has further flattened as a result, with some tenors inverting. We focus on the yield curves that show the spread between the 10-year yield and the 2-year and 3-month yields. The 10/2 spread is close to inversion, currently sitting at 14 bps in the U.S. and 7 bps in Canada. While the 10/3-month spreads are 48 bps in the U.S. and 45 bps in Canada. None of these curves have inverted, and even when they do, there is debate over how far in advance these warnings portend an economic slowdown and how far in advance of that will equity prices drop. Our conclusion is the flat yield curve is flashing an amber warning (proceed with caution), not red (all out stop). We see these as signals that growth is past its peak and set to moderate, not outright contraction; it’s also the bond markets’ way of signaling to central bankers their tightening cycles are running their course.
We’re not overly concerned with the week’s equity decline. The price action is consistent with what we’ve been saying since the correction began in early October. The technical damage done when the S&P 500 broke below its moving averages will take time to repair and necessitate some volatility (i.e., the -6.4% intra-week swing). The S&P 500 has strong support at the 2,600 level and the upside of 2,800 is where selling pressure appears, the market continues to hold this range. We’re encouraged by the positive signs from the broad improvement in PMI readings, solid North American employment data, stabilizing oil prices and that emerging markets are up 4.6% since the end of October, even though stocks are presently choosing to ignore these positive signs.
Chart of the Week: Trade Tensions (“Tariff Man”) Torpedo the Ten Year
North American bond yields have collapsed in Q4. The decline is very similar to the May-to-June drop, fueled by fears of slowing global growth and heightened trade troubles. However, this time around, the decline is being aided by a sharp shift in the tone emanating from the U.S. Federal Reserve and the Bank of Canada. Back in the spring, both central banks were steadfast in their commitment to raising rates back to their view of the neutral zone (between 2.5% and 3.5%). Today, with both banks having administered three 0.25% hikes in 2018 (and the Fed still expected to add a fourth on Dec. 19), the discussions are shifting to when they’ll end their tightening campaigns, based on a recognition that their neutral rate views are likely too high. For Canadian bond investors, the YTD -1.4% decline reached on October 5 has since become a YTD 1% gain. The two-month, 2.4% rebound is a welcome tonic for balanced investors, as the S&P/TSX total return has swooned -6.75% over the same period.
The Week in Review
Canadian employment (Nov.) rose a massive 94,100 (versus +10,000 expected), led by 90,000 new full-time positions. The unemployment rate fell 0.2% to 5.6%. The only weak details were a drop in the participation rate of 0.2% to 65.4% and hourly earnings growth decelerated 0.4% to 1.5% y/y.
The Bank of Canada left policy rates unchanged at 1.75% as expected. The tone of the statement was more dovish than expected.
U.S. employment (Nov.) rose 155,000 (versus 198,000 expected) and the unemployment rate held steady at 3.7%, the lowest level since 1969. Average hourly earnings rose 3.1% y/y (as expected), unchanged from the previous month.
November PMI recap – Nearly universal improvement: U.S. ISM manufacturing rose 1.6 to 59.3, non-manufacturing rose 0.4 to 60.7; Canada manufacturing up 1.0 to 54.9; Eurozone manufacturing up 0.3 to 51.8, services up 0.3 to 53.4; U.K. manufacturing rose 2.0 to 53.1, services fell 1.8 to 50.4 (the weakest since the Brexit vote); Japan manufacturing up 0.4 to 52.2, service fell 0.1 to 52.3; and, China’s Caixin manufacturing rose 0.1 to 50.2, services rose 3.0 to 53.8.
Alberta is mandating 325,000 bbls/d of oil production cuts (8.7% of production), effective for all Q1/19, following which the curtailment is reduced to 95,000 bbls/d. Canadian oil price differentials narrowed sharply with the price of WCS rising 72% to $37.61USD/bbl.
OPEC and its partners agreed to cut oil production by 1.2 million bbls/d, more than the market had been expecting.
Bank earnings – BMO and National Bank both beat earnings estimates and raised their dividends.
The Week Ahead
Canadian housing data
U.S. inflation, retail sales and industrial production
ECB monetary policy announcement
U.K. parliament expected to vote on Brexit deal
Have a great day!
Your Wealth Management Resources Team at Capital Core Financial