October Market Update

November 01, 2017 | Rita Li


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Has The Market Become Too Expensive?

 

Since the first quarter of 2016, six quarters ago, the global stock market has had an amazing run, rallying more than 30% (for the S&P 500) against record low volatility and without a single 10% correction. This is historically very unusual and therefore, statistically unlikely to be sustainable. On the other hand, the economic fundamentals have been improving. Global manufacturing indexes are in the expansion territory, unemployment rates remain low and U.S. consumers have achieved milestones in repairing their household balance sheet.

 

There are many possible threats that could impact the market and result in one or multiple corrections. On Monday, Oct 30, 2017 the market shrugged off the first charges from Robert Mueller’s investigation into the Trump administration.  At some point, the uncertain political regime can produce volatility in the market that is beyond investors’ control.

 

While a short term market correction is possible and even likely, given that Fixed income is still producing 2-3% rate of return, Equities is still the more attractive asset category to be in for long term investors. Economic recovery in the Eurozone and earnings growth continue to support our underpinning thesis for geographic diversification outside of U.S. and Canada.

 

Fall Third Quarter Company Earnings Update

 

We have stressed the importance of companies’ reported earnings in determining the future direction of the stock market. In the past, all the asset categories, not just stocks and bonds but also real estates have benefited from the unprecedented easing of liquidity conditions, going forward, the valuation will need to be supported by strength in the economy as well as growth in corporate profit.

 

For S&P500 companies that have reported their third quarter earnings, the headline earnings growth rate is 5.3% y/y. It is important to note the growth rate can be misleading because it includes extreme losses for property and casualty insurers from the hurricanes that hit Houston and Florida. Excluding the insurers, S&P500 third quarter earnings grew by 8.1% year over year.

 

Company Q3 reported earnings: U.S., Eurozone, Japan

Source: Bloomberg, JPMorgan

 

An Update on the Canadian Currency

 

As always, the future direction of the Canadian dollar versus the U.S. greenback is top of mind for Canadian investors. We have witnessed an impressive rally since the Bank of Canada governor Stephen Poloz raised interest rate unexpectedly. Canadian dollar rallied past 70 cents and is now trading at closer to its long term value around 80 cents. 

 

Short term exchange rate movements are primarily dominated by the interest rate differentials between two countries. When we graph the Canadian dollar and the spread between Canadian and U.S. two year government bond yields, which captures the current and expected relative paths of monetary policy in the two countries, we can observe a near perfect correlation in recent years.

Therefore, forecasting short term Canadian dollar is to forecast the interest rate differential between U.S. and Canada. Our view is even though the Bank of Canada governor can be unpredictable at times, we expect Bank of Canada to return to lagging behind the Fed’s tightening cycle. The primarily reason is Canadian households now have higher debt levels than where the U.S. households were at their peak. Unlike the U.S., Canadian households have not started repairing their balance sheets. Canadian economy now have much greater interest rate sensitivity than the U.S. and much less room to absorb any interest rate shock.

 

 

 

Rita Li, CFA, MBA, CFP

Rita is a seasoned investment professional with experience working with different asset classes at top investment firms in Canada and abroad.  Rita is a Chartered Financial Analyst CFA® and Certified Financial Planner CFP®. She works with a multi-disciplined team to provide comprehensive wealth management services to High Net Worth families.

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