Smart Money

Our regular summary of the capital markets. Check back each month for new updates.

Smart Money

July 29, 2019

Positioning For A Game Changer

Second Quarter 2019 Newsletter

Volatile But Solid Quarter – Equity markets were broadly higher last quarter despite an escalation in US-China trade tensions and concerns of a global growth slowdown. The US once again led the group, returning 4.3% during the quarter and 10.42% over the trailing 12-months. The market rally was driven mostly by major central banks shifting their tone more clearly toward an easing bias...

Volatile But Solid Quarter – Equity markets were broadly higher last quarter despite an escalation in US-China trade tensions and concerns of a global growth slowdown. The US once again led the group, returning 4.3% during the quarter and 10.42% over the trailing 12-months. The market rally was driven mostly by major central banks shifting their tone more clearly toward an easing bias as they acknowledged the weak global economic backdrop.

Safe-haven assets such as government bonds and gold were also among the biggest gainers on expectations of interest rate cuts and the possibility of further monetary easing. The Canadian dollar advanced 5.66% against the greenback as US interest rates collapsed and the Canadian economy recovered from its first quarter stall.

Paradigm Shifts & Turning Points – For those that have followed the National Hockey League closely, the paradigm shifts with regards to how the game is played have ebbed and flowed. The transitions from the “Run & Gun Era” (1984-‘94), to the “Dead Puck Era” (‘94-2004), the “Golden Era” (‘05-’15), and finally the “Precision Era” (’15-Today), required changing skill sets to generate success. During each turning point, teams that drafted and prepared well for the shift benefitted the most; Edmonton Oilers, New Jersey Devils, Chicago Blackhawks and Pittsburgh Penguins.

Analogous with eras in hockey, markets experience long-term changes that require structural modifications to portfolios. Early adopters typically see the largest benefits as teams/capital begin to accept and eventually mimic/support the strategy. In due course, a “New Paradigm” is declared because individuals become heavily influenced by current events. It is assumed the existing view will persist but the vast majority fail to anticipate shifts caused by the law of diminishing returns. The transition to a new path begins when a consensus view creates excessive optimism, encourages abnormal risk-taking and distorts valuations.

The 10-year time frame works in hockey and it also appears to hold up well in markets. Looking back at the last four decades there are distinct beliefs that become psychologically engrained in society. These prominent convictions become reflected in markets through valuations that teeter into “bubble territory.” Accordingly, avoiding the previous dominant themes and the largest stocks associated with the era can lead to outperformance over the next 10-years. The table below demonstrates this phenomenon.

1980 to 1989

  • Beginning

Inflation exceeded 10% and bond yields were rising rapidly. Top 10 global stocks included five energy companies and nine were US domiciled.

  • Ending

The best allocation decision was to underweight the US to hold zero energy companies as inflation receded.

1990 to 1999

  • Beginning

Japanese equities dominated, owning eight of the top 10 equity positions by size while accounting for 45% of the global index. The core belief was Japan’s corporations held superior management techniques and banking systems.

  • Ending

Simply underweighting Japan allowed a global investor to outperform as the Tokyo exchange peaked in 1990.

2000 to 2009

  • Beginning

The internet and housing boom fostered the “new economy”. Technology, media and telecom stocks (TMT) comprised more than one-third of the MSCI World.

  • Ending

Investors that performed well in the 2000s owned commodities and sold TMT.

2010 to 2019

  • Beginning

Quantitative easing stoked concerns of inflation once again, while China’s growth and talk of peak oil helped push Chinese and commodity equities into the top 10.

  • Ending

Best trade for 2010s was to underweight China and to be short commodity stocks.

Paradigm shifts do not signal a bleak future; conversely, the transition often leads to net gains. Technology stocks once again dominate the top 10 board by market share and the US now accounts for 56% of the MSCI World Index. However, the seeds that were sowed for this decade’s rich harvest are beginning to become unviable, similar to the one-dimensional enforcer in today’s NHL.

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July 26, 2019

Equity Markets Rise Amid an Uncertain Economy

Market Recap & Box Score

Markets continued to perform well in July with the US leading the way.  The S&P 500 posted a 3.6% gain for the period.  The MSCI World and TSX lagged but still recorded strong gains, at 2.6% and 1.8%, respectively.   In the US, technology (+7%) and financials (+6%) were leaders while healthcare and energy trailed. Expectations for lower short-term rates are a significant factor in...

Markets continued to perform well in July with the US leading the way.  The S&P 500 posted a 3.6% gain for the period.  The MSCI World and TSX lagged but still recorded strong gains, at 2.6% and 1.8%, respectively.   In the US, technology (+7%) and financials (+6%) were leaders while healthcare and energy trailed.

Expectations for lower short-term rates are a significant factor in the markets upward trajectory.  Growth sectors, such as technology, disproportionally benefit from lower rates because the cost of funding and discount rate produce a higher present value for these businesses.  Financials are assessed differently because their valuation is derived from the yield curve, or the difference between long and short-term interest rates.  Banks borrow on the short end and lend on the long end of the yield curve.  Profitability is boosted when longer-term interest rates are higher than short-term.  This worked against the financial sector in 2018 as the Fed sought to increase rates while the markets continued to price in low growth through suppressed long-term rates.  In 2019, the trend has reversed.  If the Fed allows inflation to “run hot”, the case can be made that the yield curve will steepen further, and momentum in financials will persist.  The yield for the US 10-Year Treasury rose 11bps during the month, while WTI oil softened 2.6%, despite inventory data the was fundamentally strong.

Second quarter earnings season kicked off during the month.  General expectations for Q2 were fairly bleak, especially lapping a robust 2018 when earnings were boosted by Trump-enacted tax cuts.  Further, wage pressures, increased raw material (oil) costs, and global weakness in manufacturing and economic data were foretelling dim results.  However, most companies have beaten expectations on both top and bottom-line numbers.  Also, on 26-Jul-19, the US declared initial Q2 GDP growth of 2.1%, overcoming Wall Street estimates.  With companies broadcasting solid results, a stubbornly resilient US economy and a supportive Fed, equity markets have potential to maintain an upward path.  The downside case is supported by valuations that exceed historical averages and underlying indicators (inventory builds, government outlays, weak imports) that reveal softness in the economy.

As it relates to potential weak spots, the auto industry should be on the top of investors’ list of canaries.  In the US, Ford disappointed and its stock lost up to 9% on the day of its earnings release.  Guidance was cut and hints about capacity reductions continue.  Overseas, Daimler (Mercedes-Benz), reported its first quarterly loss in a decade, though from a volume perspective, things were not as weak as headline numbers indicated.  The company absorbed a €4.2 billion charge on diesel vehicle and air bag recalls.  In the UK, stock of Aston Martin collapsed over 40% due to a reduced profit forecast.  Meanwhile in Japan, Nissan announced 12,500 job cuts, or 10% of their workforce, as operating profit fell 99%.   Globally, auto markets are one of the largest employers.  Accordingly, when the sector faulters, it augurs poorly for consumer health, and in turn the economy.

Precious metals had an interesting month as gold took a breather after a very strong June. Conversely, silver ascended 7.2%, in an attempt to close the gap with gold in 2019.  It is important to try to make sense of the fuel that is propelling gold.  According to Commitment of Traders report, speculators and producers are crowded on the long side, while expectations for rate cuts from the Federal Reserve are at extreme dovish levels.  This has been the case for most of the bull run, yet prices withstand the strain.  In a slow growth, benign inflation world, where $15 trillion of global bonds exhibit negative yields, gold becomes an enduring and attractive asset.

In contrast to gold, industrial metals, are used in a wide variety of construction and manufacturing applications. As such, copper prices, for example, can be a barometer for the economy.  In July, at a time, when gold prices paused, copper may have found a bottom in its downward cycle that began in early 2018. The price movement of these two metals could have predictive power for the course of growth and interest rates.

 

June 27, 2019

An Offer They Can’t Refuse?

Smart Money

A player will find themselves in one of two situations when their NHL contract expires, either an unrestricted free agent (UFA) or restricted free agent (RFA). UFAs have the ability of select from among the teams who have offered a new contract. However, this luxury is only tendered to players who meet the minimum age and/or service requirements. For those classified as RFAs, the abil...

A player will find themselves in one of two situations when their NHL contract expires, either an unrestricted free agent (UFA) or restricted free agent (RFA). UFAs have the ability of select from among the teams who have offered a new contract. However, this luxury is only tendered to players who meet the minimum age and/or service requirements. For those classified as RFAs, the ability to negotiate is much more limited. Check out the link below as the rights for an RFA are explained.

A Guide for the Restricted Free Agent