North American equity market and interest rate outlook
Monday, 16 April 2018

Equity market in North America

Every observer of North American equity markets is painfully aware of the sharp increase in volatility in recent months. Thus, the VIX (the S&P Volatility Index) had been in an unusually long period of low volatility. From October 2016 through the end of January 2018, the VIX never surpassed the 20 level. In much of February, March and April 2018, it was above 20 with a very elevated high of 50 in early February but with an April 13th close of 17.40.

Both the S&P 500 and the TSX hit all-time highs in January – at 2,873 for the former and 16,421 for the latter. In early February, both indices hit lows of 2,532 and 14,786 respectively. Technical analysts feel happier when stocks or indices retest lows but fail to break below them. That has been the case to date with both the S&P 500 and the TSX. The former bottomed again at 2,553 in early April while the TSX bottomed at 14,990 also in the first week of April. Technicians would be more encouraged by the fact that the S&P 500 – as at April 13th at 2,656 - is above its 200-day moving average of 2,615 while the TSX at its April 13th close of 15,273 is still below its 200-day moving average of 15,645.

The obvious question is: where do we go from here? This economic cycle is now nine years old and we are getting late in the cycle. With interest rates remaining extremely low by historical standards, it is hard to envisage a North American recession in the near term and, as we have pointed out in previous Strategy Notes, North American bear markets have coincided with U.S. recessions nine out of the last 10 times. We have recently interviewed four of the major five Canadian banks (with a BNS interview due later this week). RBC’s CEO put it best when he said that the U.S. economy is likely in the eighth inning of this cycle although it could well go into extra innings. None of the four banks we have spoken to foresaw a U.S. or Canadian recession before 2020 at the earliest.

In addition, we were surprised in these interviews about the various banks’ optimism about their operations in the U.S. For example, the head of TD’s U.S. operations had recently visited all the bank’s main operations between Florida and Massachusetts. He was very encouraged by the positive outlooks expressed by both their corporate and individual customers. The recent business and individual tax cuts flow straight to the bottom line and are immediately visible. Fears about the deleterious impact on the U.S. federal deficit are valid but are not impinging on favourable sentiment in the short term. 


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Quarterly Market Outlook
Monday, 02 April 2018

Stock market outlook

A) The very long term

As we have pointed out in previous Quarterly Market Outlooks, the unprecedented liquidity injection by the developed world’s major central banks has made short term market forecasting very difficult. We, therefore, thought it would be helpful to update our views as to where North American markets in general and the U.S. market in particular might be situated in a longer term perspective.

As regular readers of our Strategy Notes will know, we have always been interested in market cycles. We divide these into cyclical and secular cycles. On average, secular uptrends comprise several four to four and half year cycles and can last anywhere from 10 to 30 years. Over the last 120 years, there have been four secular bull markets. The first took 13 years from 1896 to 1909 and saw the Dow Jones Industrial Index gain over 200%. The second was in the 1920’s (1920 to 1929) and resulted in a 300% gain. The third lasted 30 years (1942-1972) and resulted in a gain of almost 800%. The fourth secular bull market was the biggest of the four and saw the DJII gain almost 1400% (from 1982 to 2000).

Secular downtrends tend to be shorter than secular uptrends – roughly 12 years on average versus 18.5 years for the average secular bull market – although the current secular bear market has lasted 17 years. In contrast, compared to the normal four to four and a half year cycle, the current cyclical bull market has lasted almost nine years from its inception in March 2009, making it the second longest in history. Cyclical bull markets do not die of old age. They normally end as a result of a recession (nine out of the last 10 times in terms of the U.S. market). The extended cyclical bull market owes much of its unusual length to the extraordinary monetary measures taken since 2009 by the Federal Reserve Board.

The good news as we expand on in the section below in regard to the shorter term market outlook is that we do not currently see an imminent risk of a recession ending the bull market over the next 12 months unless there is a major unexpected exogenous shock to the U.S. economy (trade wars could fit into this category). Although this cycle is “long in the tooth”, the moderate recovery in U.S. GDP would likely result in a drawn out cycle. In sum, it is still our view that we will see one more cyclical bear market before the current secular bear terminates.

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Predictability of long term dividend growth for the companies in our Infrastructure Growth portfolio
Thursday, 01 March 2018

Stock market outlook

Two weeks ago, in our February 15 Note, we wrote that it had “been quite the two weeks in financial markets – both globally and in North America. Volatility rose sharply. For example, the VIX – a measure of volatility of the S&P 500 –intra-day, touched 50 in the week of February 5, the first time it had surpassed 30 since the mini-panic that occurred in August 2015 following the surprise mini-devaluation of the Chinese currency. In contrast, through the whole of 2017, this measure of volatility never even surpassed 20. The major result of this volatile activity in markets – including bonds as well as stocks – has been a refocussing by investors on risk.” In the ensuing two weeks to March 1, the volatility has diminished with the VIX ranging between 16 and 21 (currently as at February 28, at just under 19). As we pointed out two weeks ago, historically, whenever the VIX has exceeded 40 and then reversed back down below 20, markets have tended to stabilize and improve after a few days/weeks. We referred also two weeks ago to technical support levels, which are often used by technical analysts based on previous short term bottoms. In the case of the TSX, the preceding short term bottoms for the TSX were 14,500 in November 2016 and 14,900 in August 2017. We said in our previous Note that we would have to see whether a range between 14,500 and 14,900 would hold over the next few days/weeks and create at least that short term bottom. So far that has held true as the TSX bottomed, at least on a short term basis, at 14,785. As we go to print, it has since recovered to 15,598.

In sum, we think it is worth repeating what we said two weeks ago: “Although our recent presentations on our ‘Outlook 2018’ have been emphasizing our view that we are likely in the eighth or ninth inning of this equity bull market cycle which started in March 2009, we suspect that the recent weakness is unlikely to be marking the immediate onset of an equity bear market. Almost invariably, bear markets precede or are coincident with recessions (the October 1987 Crash was an exception) and as we have explained in recent Strategy Notes, the reliable leading indicators that we use (the ECRI Weekly leading Indicators –WLI- and real M1 growth for G7 and major emerging markets) do not suggest, at this stage at least, much likelihood of a U.S. or global recession in 2018.” They do, however, indicate a loss of economic momentum in both North America and globally in the second half, which would perhaps indicate that the current upwards thrust in long term interest rates may –even if temporarily –be reversed.

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