To my clients:
It was an up week for North American stock markets with the Canadian TSX rising 0.2%; the U.S. Dow Jones Index rising 0.7%; and the U.S. S&P 500 rising 1.2%.
After a heavier than usual update last week that generated possibly the most feedback I’ve received on any update since the heights of the 2008 recession, I’ll keep things modestly lighter this week. On tap are brief observations on: U.S./China trade negotiations; QE by another name; and corporate earnings that continue to come in better than expected. Based upon the reactions to last week’s update, it seems there will be plenty of conversation on portfolio positioning at our pending 2019 reviews. If you missed last week’s update, here’s the link: Ultra-Low Interest Rates and the Challenge Posed to "Balanced" Portfolios
On the trade front, a statement issued earlier today by the Office of the U.S. Trade Representative (Office of the USTR) indicated that “progress” has been made toward finalizing some parts of the Phase 1 deal announced two weeks ago. This progress was made during direct high level discussions between U.S. Trade Representative Robert Lighthizer, Treasury Secretary Steven Mnuchin, and Chinese Vice Premier Liu He. Given that the statement was issued directly by the Office of the USTR, and involved the top negotiators from both countries, this particular development seems notable – and the markets responded accordingly mid-morning. The Office of the USTR further noted that “discussions will go on continuously at the deputy level, and the principals will have another call in the near future”. As long asserted, I believe a meaningful (though not necessarily all-encompassing) trade agreement will be reached before the 2020 U.S. election. While this “Phase 1” deal is not the meaningful breakthrough I reference, it continues to be a step in the right direction.
In a bid to counter growth headwinds and inject more cash into the financial system, major global central banks have started to expand their balance sheets anew. “Expand their balance sheets” is industry jargon for “buying bonds”, otherwise known as Quantitative Easing (QE). Recall that in the aftermath of the 2008 recession, central banks – particularly the U.S. Federal Reserve – embarked upon multi-year programs of bond buying in an attempt to force down longer-term interest rates and stimulate the economy. While there were undoubtedly consequences to these QE programs (some of which are probably being seen in recent yield curve inversions), it seems likely that the programs were also successful in their immediate aim of economic stimulus. It is therefore noteworthy that the Fed recently announced that it will be buying ~ $60 billion per month in U.S. Treasury bills. The Fed emphasized that the new scheme is “technical” in nature, and was implemented to address issues that popped up about one month ago in the overnight bank lending market. I did not comment upon the matter at the time because the nature of this overnight lending market is very complicated, and frankly I have little knowledge of that area of the market myself. Nonetheless, while the Fed has taken pains to play down its recent bond buying actions, and seems keen to dispel the notion that it has begun yet another iteration of QE, the fact is that the effect is more or less the same. Per one of RBC’s Global Equity Strategists: “improving liquidity conditions on the back of global monetary easing should remain supportive of risk appetite and help shore up the growth outlook for the world economy in the months ahead.”
Finally, U.S. corporate earnings continue to track modestly better than expectations. I have three very quick observations here:
1) earnings coming in better than expectations is typically the case. For whatever reason, when analysts first estimate profits for a particular quarter, they almost always skew too optimistic in their outlook at the start of a quarter, but then as developments occur over the ensuing three months, their estimates are revised lower. The vast majority of the time these revisions swing too far the other way such that when results are actually released, the results “beat” the collective estimate of analysts. I suppose this is a commentary on human psychology as much as anything else, but it is a scenario that plays out very regularly;
2) while on the one hand profits are beating expectations, on the other it is also true that they are contracting from their recent highs. In other words, profits are shrinking, just at a lesser rate than anticipated. That profits are shrinking amidst a slowing global economy, and coming off of tax cut supercharged earnings numbers of a year earlier, is not entirely surprising. That said, this is a significant caveat to bear in mind and to watch for a continuation of trend; and
3) despite the caution warranted by #2 above, it is also true that one must really start to worry if earnings begin to come in below the collective estimate of analysts. Such outcomes often mark inflection points for stock markets as well as for the overall economy. We are not there.
Overall, while the economy and markets remain at a tricky juncture overall, our base case expectation remains that the U.S. economy will avoid recession, and that corporate results (and hence, all-in stock returns) will track a broader recovery in economic growth. Portfolios remain positioned for such an eventuality.
That’s it for this week. All the best,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
Scholte Wealth Management
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