Market Musings

By: Erik Moisan

The markets, both equity and bond, had a tough 4th quarter thus far, and 2018 has not been a banner year. On the whole, a balanced portfolio of roughly 50% equities and 50% bonds invested in the market indices in Canada would be down about 4.5%. The equivalent portfolio invested in US indices would be down roughly 1%. Europe offered no respite from these foul markets. Fortunately, our clients are faring better than the indices results, but we are far from satisfied with the results this year so far. We are hoping that the current positive economic and market data will translate into positive results for December 2018.

Let me justify:

Current economic data is supportive of equity markets.

• Current earnings growth remains healthy, as the corporate world continues to expand.
• Matching this positive is the employment picture: the numbers are good – not the best that we have seen during this last expansion, but still healthy.
• 3rd Quarter US GDP came in at 3.5% - a good clip.
• Retail sales in the US are strong, look for a good number in Q4.
  
  

From the perspective of our “early warning” signals, all is clear for the moment:

• The spread between the 2-year and the 10-year remains positive, currently at 24 basis point
• The ISM PMI (Institute for Supply Management’s purchasingmanagers’ index), a significant and widely used indicator, remains above 50. This indicator can often be below 50 (scale of 0 to 100), so it is not a standalone indicator. But its predictive power lies in its historical consistency of always being below 50 in a recession. So I like using it in conjunction with other indicators, like those listed here.
• The new Fed model for predicting recessions by using the spread between the current 90 day interest rate and the 90 day rate, projected out insix quarters, remains positive as well.
  
  

So, if the above is all true, and supportive of the markets, you may ask WHY? Why did the markets fall so much in October? Why did the markets not recover more quickly in November?

In an attempt to provide some answers, I will ask you to please consider the following:

• The economic surprise index for the G10 has been dipping into negative territory, meaning that there have been more negative surprises than positive.
• Italy’s economic woes (debt to GDP at about 137%) have prompted renewed skepticism about how sound things are there. The direct impact was felt in the markets, most severely by European bank stocks, driving Euro markets down (9.6% this year thus far…)
• Interest rates in the US moving higher. This always makes the markets nervous.
• The level of investment leverage is quite high, which, in a pull back, creates significant selling power. As a result several technical indicators are indicating that the market (S&P500) is significantly oversold.
  
  

So what is our conclusion? While we feel that the current level of the market is low, we recommend being neutral as far as equity exposure stands. This means being “at policy” or “as per your investment policy”. We would not suggest that this opportunity argues for an overweight equity exposure is called for.

Stay the course.

As always, we welcome your comments and questions.

Enjoy the holiday vibe.

Wishing you a great month of December.

Erik