By Miles Clyne
Multiple times since the S&P/TSX Composite reached its high in 2008 it has come back to that number. The drubbing the index took in the months leading up to the New Year brought us below the 2008 high once again. Will the tug of war with this seemingly fateful level never end?
The primary Canadian index clawed its way back slightly above the fateful level of 15150 once again, driven by the markets in the US and Canada extending their New Year’s Rally into this third week of the month. Both Canadian and US investors responded favourably to the first round of earnings. Although results have been mixed relative to estimates, positive numbers have encouraged investors sufficiently to raise the markets whereas negative numbers really haven’t seemed to diminish enthusiasm.
This suggests that the selloff since the last earnings season may have brought valuations down sufficiently to where minor misses from companies have been factored in and positive earnings more the norm. Earnings season accelerates over the next week, we should know better if optimism will trump pessimism for the short term at least.
Rising interest rates had been a drag on stocks and bonds in 2018. The easing of the more aggressive rate increase agenda coming from both the Central Bank in Canada and the US is a main contributor to the renewed enthusiasm in the markets. Very uncomfortable trade tensions and the collapse of energy prices have played a big part in easing inflation pressures domestically and in the US. The fact that China has recently indicated the potential for fiscal and monetary stimulus to shore up its economy would be another key factor in Central Bank decisions.
How bad was 2018 – pretty bad on all accounts:
· The drop in January was 8.4%
· The drop from July through September was 2.88%
· The drop in October was 8.41%
· The drop in December was a record setting 9.79%
· The total of these drops was almost 30%.
Given the reversal of the markets in January, having now all but erased the pain of December, what has changed and are we out of the woods regarding the extreme negative volatility for a reasonable amount of time? I pointed out a number of factors that likely influenced the Cdn. and US Central Banks taking a more measured approach to interest rate increases, which seems to be the impetus for markets beginning to recover. That’s it, now it’s fixed and we can happily continue on our way? I wish it were that easy.
The big issue that governments don’t want to address is the debt crisis that virtually every country is currently in. A primary driver that can accelerate excessive debt is low interest rates for an extended period of time. Low interest rates drive up the cost of most assets: real estate, stocks, certain types of bonds and other goods. This is called inflation. The process of normalizing interest rates ultimately means the revaluation of assets that appreciated because of the abnormally low interest rates.
Removing the excess debt in governments, businesses and personally is what needs to happen. You pay it off. If you can’t pay it off, and rates keep increasing, it is only a matter of time before defaults begin to happen. We have first-hand experience of what happens to countries struggling to pay their debt. Argentina, Portugal, Italy, Ireland, Greece and Spain to list a few. What happens when a country defaults?
Central Banks know the laws of economics, this is why they are to act independent of governments and protect their countries from irrational fiscal policy with prudent monetary policy, but are they? Would Trudeau, Trump or any politician want to see real-estate, stocks, bonds and likely many other asset prices cut in value dramatically? If it happened on their watch, would they be reelected? Yet they know we are walking a dangerous line given our countries levels of debt being at record levels. That rattling sound you keep hearing is the can being kicked a bit further down the road.
In our equity strategies, for the time being, we are overweight in cash. We are comfortable with this, regardless of the short-term behavior of other investors. If we are to have a different experience in the market, and do not prefer the Deja vu cycles in the markets, you need to do something different than what the market is doing.