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Week Ending: May 17th, 2019
Published: May 21st, 2019.
Global equities were mixed on a volatile week marked by continued rhetoric around trade – some to the good, and some bad. The bad was focused on U.S. and China trade frictions and U.S. and emerging market equities suffered more than their global peers. The U.S.-China trade woes escalated with China announcing plans to increase tariffs on $60 billion of U.S. imports starting June 1. The U.S. Trade representative started the formal process (hearings and timeline now in motion) to be able to attach the new 25% tariff on Chinese imports from $200 billion worth of goods, to over $500 billion worth as early as June 24th. While there are hopes for talks to re-start, those hopes are fading. China has alluded to seeing no reason to restart talks and the U.S. adopted more antagonistic measures by taking steps to restrict Chinese tech giant Huawei’s ability to do business with U.S. entities. While it is difficult to forecast the exact path of the ongoing U.S.-China negotiations, we still view a trade deal as the more likely outcome, with the assumption that both administrations cannot afford a sharply negative equity market reaction, nor any further slowdown in their respective economies. In an odd twist of fate, “bad news is good” when it comes to weak U.S. and/or Chinese economic data, as this is now viewed as a catalyst to resume productive trade talks.
The good news on trade was between the U.S. and several of its other relationships. President Trump has put off making any decision on European and Japanese auto tariffs for six months; and the U.S., Mexico and Canada reached an agreement to remove steel & aluminum tariffs, meaning one less barrier to ratifying the USMCA trade deal.
Bond yields continue to take a much more pessimistic view of the world. This is understandable given soft U.S. and Chinese economic data, Iranian and broader Middle East tensions flaring-up (pushing oil prices higher, which helped Canadian equities), and the return of Brexit concerns.
We see the moves in fixed income and equites as incongruent. Stocks can’t continue to cheer lower yields simply on the basis that the U.S. Federal Reserve will cut interest rates, without also recognizing that this kind of economic weakness suggests earnings expectations would be negatively impacted. We think both markets might have it wrong; with yields being too pessimistic and equities too optimistic. If they are both just a little bit wrong, then a smaller correction in both is possible. If one of them has it right, then the other is in for a sizable negative adjustment.
Chart of the Week: Bonds Top Stocks Over Last 12-Months
The total return of Canadian bonds (including interest) has outperformed Canadian stocks (including dividends) over the past year. The result is even more surprising when we consider that over the past year it was equity markets that had the ‘yield advantage’. The dividend yield on the S&P/TSX Composite one-year ago was 2.9%, while the yield on the FTSE Canada Universe Bond Index was 2.7%. While some may have thought a year ago that bonds would outperform equities under fears of a forthcoming recession, we doubt that few thought the two would end up with returns as closely aligned as they did. We have held a neutral asset mix recommendation for about a year – a view that was, and continues to be, born out of seeing enough encouraging signs for stocks, while respecting that growth is slowing and risks can materialize quickly. Today, our outlook tilts slightly in favour of stocks outperforming bonds over the next 12-months – but enough uncertainty remains to keep us from wavering far from neutral.
The Week in Review
Canadian CPI inflation (April) rose 0.4% m/m (in line with expectations), pushing the yearly rate up 0.1% to 2.0% y/y. Two of three core measures slowed slightly, with core inflation running just shy of 2%.
Canadian existing home sales (April) rose 3.6% m/m seasonally adjusted (versus 1.8% expected). Sales were up 4.2% y/y, the first such increase since the stress test changes were brought in at the start of 2018.
Canadian manufacturing sales (March) rose 2.1% m/m (versus 1.5% expected), partly driven by higher petroleum prices.
U.S. retail sales (April) fell 0.2% m/m (versus +0.2% expected), but followed an upwardly-revised 1.7% increase in the prior month and in contrast to retail bellwether Walmart posting best same-store sales growth in more than a decade. Consumer fundamentals remain supportive, despite this disappointing result, in what is generally a volatile series. University of Michigan Consumer Sentiment Index (May) jumped 5.2 to 102.4, a 15-year high.
U.S. industrial production (April) fell 0.5% (versus flat expectations), led by disappointing results in the manufacturing and utilities sectors. The capacity utilization rate slid to a 14-month low of 77.9% from 78.5%.
Eurozone real GDP (Q1) grew 0.4% q/q (in line with expectations) or 1.2% on a y/y basis. Inflation (April) was confirmed at 1.7% y/y while core inflation was revised higher to 1.3% y/y and industrial production (March) fell 0.3% m/m, or -0.6% on a y/y basis.
Data out of China was weak. Retail sales (April) rose 7.2% y/y (versus 8.6% expected). Industrial production slowed to 5.4% y/y (versus 6.5% expected) from 8.5% in the prior month. Fixed-asset investment came in at 6.1% YTD (versus 6.4% expected), down from 6.3% in the prior month.
The Week Ahead
Canadian retail sales
U.S. durable goods orders and housing data
Minutes from recent U.S. Federal Reserve meeting
Purchasing manager indices globally
European Union Parliamentary elections
Have a great week!
Your Wealth Management Resources Team at Capital Core Financial