Woulda, Coulda, Shoulda... But Comfortable I Didn't

Feb 07, 2020 | Nick Scholte


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As expected, Manufacturing has indeed rebounded and confirmed strengthening economic readings elsewhere. But coronavirus concerns keep me from adding back equity. This may change early next week.

To my clients:

It was an up week for North American stock markets with the Canadian TSX finishing up 1.9%; the U.S. Dow Jones Index finishing up 3.0%; and the U.S. S&P 500 finishing up 3.2%.

Owing to the strong returns seen this week, it’s tempting to question oneself with the old expression “Woulda, coulda, shoulda…”. Frankly however, I’m comfortable “I didn’t”. Let me explain.

In my past several weekly email updates (or, if you prefer, “blog” posts via my website), and also in my quarterly review letter to clients dated January 20, 2020, I suggested that the soft patch in economic data seen mid-2019 appeared to be resolving for the better. Employment never wavered from being strong; “services” slowed, although never contracted; weekly jobless claims momentarily “blipped” higher and then returned to generationally superb levels; and GDP continued a deceleration from the unsustainably torrid pace of 2018, but never slowed to the point that the deceleration became a self-fulfilling prophecy into contraction (i.e. recession). The lone exception amongst the key economic indicators was manufacturing, which for five straight months actually contracted.

In light of the trade conflict between the U.S. and China, it’s hardly surprising that manufacturing would suffer. Yet while still a key economic indicator, a contraction in manufacturing is no longer the harbinger of economy wide doom it once was. Representing nearly 30% of U.S. economic activity in the 1960’s, it now represents just more than 10%. Further, regional surveys that factor into the national manufacturing data (notably Philadelphia and New York) were showing very strong rebounds in activity in recent weeks. Based on this, I had suggested several times that should the national measure (the ISM Manufacturing Index) show the recovery foreshadowed by the regional surveys, I was all but certain to add back about 5% of equity (i.e. stock) to client portfolios. More succinctly, I was becoming confident that this would occur.

And occur it did. On Monday of this week, at a reading of 50.9 the ISM Manufacturing Index substantially exceeded estimates and jumped all the way back into expansionary territory. Further, the ISM Services Index also beat estimates and strengthened further to 55.5. So too today’s Employment Report at 225,000 new jobs for the month of January vs. expectations for 160,000. Oh, and weekly jobless claims, the trend in which is RBC’s second favourite gauge of the likelihood of recession? At just 202,000 newly unemployed for the week, claims are once again knocking on the door of dropping below the 200k threshold that, at one time, I never thought would be broken in my career (for what it is worth, sub-200,000 readings in unemployment claims represent 50-year lows in the metric on an un-adjusted basis… but, when adjusted for growth in the population, are easily at all-time lows).

Which brings me to the “woulda, coulda, shoulda…” title of this update. Obviously, for this week in isolation, I wish I had acted upon my convictions, and added back the 5% in equities that I had intended. But, the coronavirus outbreak in China has, in the very short-term, given me pause. While I think it would be unwise to reduce equity in light of the outbreak, mostly because similar viral outbreaks have generally had minimal and fleeting impact upon the markets, I also think it would be rash to add back equity at this moment until a more sustained trend in the deceleration of new cases is achieved. On this front, according to a third party analysis (published in the Wall Street Journal) of the nominal growth rate in the virus, the growth rate of daily confirmed cases appears to have peaked two days ago. RBC’s take is that “although we would view this as a very optimistic forecast, one or two more days of falling new cases will signal that growth of the virus has indeed crested”. I side with my firm on this front, and could easily imagine a scenario where the declining growth rate of confirmed daily cases is a result of overburdened testing labs, rather than an actual decline in the growing spread of the virus. We may well know by early next week, and I hope the Wall Street Journal’s version is the right one.

Two other items of note – one more material than the other. First the material note: in an early Valentine’s gift to the U.S., China announced that effective February 14th it would reduce tariffs by 50% on $75 billion in goods. Further, the China Finance Ministry stated "we hope to work with the United States towards the ultimate elimination of all increased tariffs”. The shift in tone between the two nations leading up to, and following, the official signing of the Phase 1 trade deal continues to improve for the better. The second, immaterial item of note, was that President Trump was acquitted in his Senate trial following his impeachment in the House of Representatives. This outcome was never in doubt and never factored into broad market sentiment nor my strategy on behalf of clients.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
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