Article
By: Erik Moisan
It has been a while since we last put pen to paper (fingers to keyboard) to share our thoughts on how things are going, what we are encouraged or concerned about, and (probably most importantly), where things are headed (from a portfolio perspective).
Indeed, time has flown by, in part due to it being summer, a time filled with absences due to well-deserved vacations, and in part due to the constant state of change and the copious amount of distractions that have manifested themselves.
As David Kelly, Chief Global Strategist at J.P. Morgan Asset Management, posted on linked in this week: “As America emerges from the pandemic, there are still serious health concerns, a yawning political divide, rising autocracy around the world, a brutal war in Europe and the highest inflation in 40 years. Moreover, anxiety triggered by these genuine problems is being amplified by cable channels and social media which ever more efficiently gather their audience by appealing to fear and outrage.“
We are still, on the whole, somewhat underweight equities. This is due to the lack of clarity about the future. Volatility has reigned supreme this year, with the broad market (as personified by the S&P500, the most diversified measure of the equity markets) being down around 20% for the year by mid-June, recovering somewhat by mid-August, only to fall sharply, reversing half of the recovery by beginning of September. September has been no difference, with volatility on both sides, both up and down, including a precipitous 4.5% fall in one day (Sept 13).
It is not surprising that many strategists and market prognosticators are saying and writing that this volatility should continue for the remainder of the year. Concerns about monetary policy and the earnings picture are present. Additional concern around global economic slowdown dominate financial headlines.
The reasons remain the same: Ukraine, Covid, central bank policies, as well as a number of other issues weighing in on the psyche.
As we have previously written, all of these issues promote tremendous uncertainty. In addition, uncertainty has a tremendously negative impact on markets.
Looking at economic data, there is a confusing mess of number. Let us go back to some of the Metrix that we have look at historically:
The ISM manufacturing index: The current read is 52.8, having consistently decreased (or the rate of expansion has been slowing) from a read of about 60 in January of 2022. As a refresher, the ISM is important with regard to recession watch because during all recessions, the ISM falls below the 50 read. However, one caveat: if the read falls below 50, it does not mean recession. It just so happens that during all recessions it has been below 50.
The CNN Fear and Greed index (Https://www.cnn.com/markets/fear-and-greed): This index measures appetite (in a sense) of the market and participants. Its current read is FEAR. While long term, this bodes well, as it suggests that there is no blind optimism, and one could extrapolate that there are less excesses. One telltale sign of a market overprice is relative to over exuberance and excesses.
Job openings have always been of great interest as a measure of economic health. Currently, while there are more jobs available than a year ago today, the numbers are still healthy. Furthermore, the unemployment rate remains in healthy territory
Wage growth is a good determinant of inflationary pressures, and while wage growth is still present (inflationary), it has shrunk consistently since February 2022.
New construction around residential real estate has fallen, based on homebuilders’ sales expectation.
Small business hiring intentions are at historically elevated levels.
Since 2005, household debt in the US as a percentage of disposable income has fallen… until roughly 2020, when the trend reversed.
Then again, household savings as a percent of disposable income are at their highest level going back to 1980, and financial obligations, while having grown since 2021, are well below historic levels since 1980.
Corporate profits, on an after tax basis are the highest they have been, growing consistently since 1985 (capitalism at its finest), both on a nominal and a real 2012 dollar basis.
Auto dealers inventories are very low (lowest since at least 1995), which means that should we have a recession, there will not be an inventory hangover, in that sector of the economy, and while new single homes for sale are up year over year since 2012 (except for 2020 – Covid), New home completions are down, offsetting that rise.
In essence, many conflictual data out there add to the confusion, and to the question about where we are is tough to answer.
Caution is key in this market. We are watching specific element, which provide for a glimmer of hope, on which we believe provide a glimpse into the future for our asset allocation going forward.
It appears, predicated on the numbers, that CPI is turning. We are seeing a turn in CPI on Goods, while services CPI is rising slightly. Note: Inflation is, in good part, too many dollars chasing too few goods….
Gasoline prices have dropped by roughly 8% since August (in the US), used car prices are down by about 4.6%, and there is a notable fall in food prices as well.
While the labour market is still showing signs of inflation, many indicators are reversing.
Arguments can be made for an easing of those pressures. As such, we are looking for the turn in inflation that will translate into an eventual turn in monetary policy. This would signal a return to lower central back prime rates. It also bodes well for bond prices, which have suffered significantly due to the rapid increases in short term rates.
Our portfolios have, in aggregate, some dry powder (cash or cash equivalent) positions that we are looking to deploy when the moment is appropriate. This includes both equity as well as fixed income securities.
Bond yield, due to rate increases are at a level that we have not seen in 15 years.
On the equity side, while we expect markets to remain volatile for the balance of the year, as the market worries about how aggressive the central bank (s) will be, as well as risk to earning due to summer slowdown, we do expect a reversal at a point. One metric that we are looking for is a FPE of 14 on the S&P 500. FPE stands for price on forward (or forecasted) earnings ratio, currently at 16.4 on the S&P 500. (Caveat: for this to happen, we need either earnings to be higher… or less down, or another important pullback…).
We recognize our own fallibility, so we do have exposures currently.
We will continue to watch markets in North America, and act according to our discipline.
As a whole, while there are compelling valuations for stock outside of North America, we are staying clear of many/most of them. We do not feel that it serves our clients to own the nicest house in what may be a bad neighbourhood.
As always, we look forward to your comments and questions, and remain at your disposal to discuss the above, or any other issues.
Wishing you an excellent end of September.
Erik and Guillaume.
Reference: https://www.ismworld.org/globalassets/pub/research-and-surveys/rob/pmi/rob202209pmi.pdf: https://www.cnn.com/markets/fear-and-greed; https://tradingeconomics.com/united-states/job-offers; https://tradingeconomics.com/united-states/unemployment-rate; https://tradingeconomics.com/united-states/wage-growth; National association of home builders; National federation of independent businesses; Federal reserve, U.S. Bureau of Economic Analysis; Federal Reserve; U.S. Bureau of Economic Analysis; U.S. Sensus Bureau; Yardeni Research https://www.yardeni.com/pub/peacockfeval.pdf
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Erik Moisan is a Portfolio Manager with Raymond James Ltd. The views are those of the author, and not necessarily those of Raymond James Ltd. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision. Raymond James Ltd. is a Member - Canadian Investor Protection Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual funds. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
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