To my clients:
First, Brenda has asked me to begin this week’s update by noting that, for the first time, RBC Dominion Securities will be making your year-end tax documents available electronically. Much like receiving monthly statements in electronic format is an optional service, so too is the receipt of electronic tax documents. If you would prefer to receive paper tax documents instead, then do nothing and you will continue to receive these paper-based documents just as you always have. But, if you would prefer to access your tax documents electronically, simply click the following link for directions on how to do so: http://dsnet.fg.rbc.com/assets/advisornet/forms/receivetaxdocs_electronic_eng.pdf. If I could editorialize for a moment, I think it’s a great idea to opt into this service. You’ll always have all your tax forms on hand and will know instantly when they might be available. If you have any additional questions, please contact Brenda at 778-328-7797 for assistance.
It was a down week for North American stock markets with the Canadian TSX falling 2.7%; the U.S. Dow Jones Index falling 4.5%; and the U.S. S&P 500 falling 4.6%.
It’s the first week of a new month and, as always, I’ll comment on the big three economic indicators (the ISM Manufacturing Index, the ISM Non-Manufacturing Index, and the monthly U.S. Employment Report). This time will be no different – except I will defer these comments until later in the update. Instead, I will begin by revisiting the “topic of the moment” these past two months – market volatility…
As seen in my market return summary above, it was a poor week for the markets. This comes on the heels of a very strong week last week. The up and down moves of the markets within the context of the current “correction” are certainly jarring and unsettling. But, as I have been stating repeatedly the past 2 months, I and RBC do indeed continue to view the current ongoing episode as a market “correction” and not anything worse. Certainly, global growth is set to slow from an unsustainably torrid pace seen earlier this year, BUT based on current economic data it DOES NOT appear set to reverse course into a contraction (which is the hallmark of a recession). Further, I reiterate my thoughts from my November 23rd weekly update and my November 20th special update suggesting that “retests” of market lows are common occurrences during corrective episodes in the markets. During the February market correction, the initial low was seen on February 8th, and subsequent “retests” of that low were seen on March 23rd, April 2nd and April 4th. This time around, the initial market low was set on October 29th, was “retested” two weeks ago on November 23rd, and has again been retested today. So far, the retests have been “successful” which means new lower lows have not been established. The more this occurs, the more likely it is that the current market range will establish itself as the ultimate low during this correction. However, I cannot and will not say that this is a certainty, just a growing statistical likelihood. But, that being said, I will cut and paste my concluding observation from my November 23rd weekly update (capitalization was in the original, although the underlining was added today):
THIS IS AN UNCOMFORTABLE CORRECTION. BUT NO EVIDENCE AS YET SUGGESTS IT IS ANYTHING MORE. TECHNICAL ANALYSIS SUGGESTS NEXT WEEK WILL BE KEY TO THE SHORT-TERM TREND OF THE MARKET INSOFAR THAT IF THE CURRENT LEVELS HOLD, THEN THE LIKELIHOOD THAT THE CURRENT RANGE IS THE BOTTOM OF CORRECTION IS STRENGTHENED. FUNDAMENTAL ANALYSIS SUGGESTS THAT THERE SHOULD BE MEANINGFUL RECOVERY FROM CURRENT LEVELS IN 2019 NO MATTER WHAT THE SHORT-TERM TERM HOLDS OVER THE NEXT SEVERAL WEEKS.
Moving on, after such a strong week last week, why has this week seen the reverse? Interesting, it likely had nothing to do with any of the big three economic indicators, two of which were very strong and one of which was probably best described as neutral. But I’ll continue to save discussion of these for later. No, the likely culprits of market angst this week were the temporary inversion of a small portion of the yield curve and the arrest of a prominent Chinese telecom executive here in Vancouver. Beginning with the yield curve, I’ve often asserted that this indicator is probably the grand-daddy of all economic indicators. When the yield curve inverts (i.e. short-term interest rates are higher than long-term interest rates), recession typically follows sometime over the following 12 to 36 months. However, it is crucial to understand which portion of the yield curve is relevant for these purposes. The most widely followed segment is the 2 to 10-year portion of the curve, with RBC preferring the 1 to 10-year portion. But the portion that temporarily inverted this week was neither of these; rather it was the 2 to 5-year portion. This smaller portion has occasionally inverted in years past and, unlike the 1-year to 10-year, it does NOT always portend recession. However, it is true that an inversion of the 2-year to 5-year portion is a necessary precursor to an inversion of the more accurate predictive powers of the broader yield curve. So, perhaps an inversion of the 1 to 10-year may be coming, but perhaps not. The 1990’s saw a very protracted multi-year stretch where the yield curve flattened in a manner similar to now, and during that prolonged stretch both the economy and the stock market grew handsomely. So I will continue to monitor the situation closely. But should the 1-year to 10-year portion invert, there are two very important points I will make: 1) markets can continue to do well, sometimes for significantly more than a year, after the inversion; and 2) despite #1, I will reduce equity exposure in client portfolios immediately because history suggests that one should pay attention to this indicator and not attempt to rationalize why “this time might be different”.
Interestingly, I suspect the greater impact on markets this week came from the arrest here in Vancouver of Meng Wanzhou, the Chief Financial Officer of Huawei Technologies – China’s, and one of the world’s, biggest telecommunication company’s. Ms. Meng’s arrest was requested by U.S. authorities. It is alleged that Ms. Meng violated U.S. sanctions against Iran by utilizing a Huawei subsidiary known as Skycom which she publicly represented as having no connection to Huawei. The arrest occurred on Saturday, nearly simultaneous with the dinner meeting between President Trump and Chinese President Xi in Argentina (I tried to find the time of Ms. Meng’s arrest to learn just how “simultaneous” these events might have been, but was unable to do so). In any event, the good news that came out of that dinner meeting (a temporary 90-day delay in enacting new tariffs against China while the two sides attempt to work out their trade differences) obviously was dealt a serious blow by Ms. Meng’s arrest. In fact, after the markets had a reasonably good Monday in reaction to the U.S./Chinese temporary truce, markets became unsettled on Tuesday when participants began to wonder why the Chinese were offering very little comment on what was discussed and/or agreed to. It doesn’t take a great mental leap to imagine a Chinese delegation becoming mightily ticked-off as they emerge from the dinner meeting to immediately learn of Ms. Meng’s arrest. Hopefully this situation can be worked out. But it underscores what I wrote last week, that the Chinese trade negotiations are part of a greater geopolitical struggle that includes “technology leadership; laws, regulations and behaviors; accusations of state interference; and ideological differences”, and perhaps both the 90-day trade ceasefire agreed to at the dinner meeting and Ms. Meng’s arrest are individual moves in this much greater chess match. Certainly the situation deserves to be monitored closely.
Ok, back to the economy in the here and now - and it remains on solid footing. The ISM Manufacturing Index came in at 59.3, surpassing both expectations and the prior month’s reading. It continues to be holding in the upper end of the range seen the past 5 years. Likewise, the ISM Non-Manufacturing (AKA; “Services”) Index also beat expectations and the prior month’s reading coming in at 60.7. This is the second best reading (only surpassed by the recent October reading) since the mid 2000’s. It was only the U.S. Employment Report that might have been described as mildly disappointing but which I’d prefer to describe as neutral. At 155,000 new jobs created for the month of November, it missed both expectations and the prior month’s reading. But there have been several reports the past 12 months that have showed a lesser number of jobs created. Further, as a whole, if next month’s reading for December can show at least 60,000 new jobs created, then 2018 will have seen more jobs created than in either 2017 or 2016, both of which are considered historically exceptional years.
So, in conclusion, stock-market activity remains volatile and unsettling. News headlines continue to feed this narrative of volatility. But underlying economic conditions remain sound. Certainly the yield curve deserves closer than usual scrutiny in the weeks and months ahead to see if the 2 to 5-year inversion morphs into anything worse, but at this juncture, the overarching economic picture remains positive and is indicative of a slowdown from unsustainably high levels, and not a reversal of course.
That’s it for this week. All the best,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
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