Weekly Capital Strategy – April 29, 2016

April 29, 2016

Central Banks Add a Brick to Wall of Worry

This was a week of anticipation regarding the direction that both the US and Japanese central banks would take following a period of relative calm in global financial markets, at least compared with the experience in January. What came out of the two meetings was anything but earth-shattering, yet equity markets were still wounded and investors are left wondering why. A question that has been asked often since the start of the year.  Wednesday’s FOMC meeting and then Thursday’s Bank of Japan gathering contained little evidence of a change in either central bank’s stance towards their respective economies. As I mentioned in Wednesday’s blog, Janet Yellen and the folks at the Fed opted for microscopic adjustments to the statement they released at the March FOMC, signalling improved global conditions but a lack of additional progress in US domestic activity. Where some had felt that there might be a more bullish assessment given labour market conditions and increases in wages, the Fed sounded  – well balanced. Hence, calls for a June rate hike remain a minority opinion and there are still more economists who have pushed out the next move to next year. Normally, that would propel stocks higher as bulls salivate over an extension of cheap credit. Instead, there is a lack of conviction in this post-January rally and, while corporate earnings have largely been ahead of street estimates, this has happened mainly by cost-cutting and not top line revenue growth.


SP500 Apr 29 2016


As for Japan, some had hoped that the central bank would expand its stimulus measures (more bond buying and yet deeper negative interest rates) to at least cool an over-valued yen. Again, no change in stance. More than the FOMC result, this decision actually led to a pronounced sell-off in stocks Thursday and deepened investor concerns.

Some will argue that if the Federal Reserve had actually hinted at a June rate hike this week the fallout in stocks would have been worse and perhaps that is correct. After all it was the Fed’s reluctance to raise rates in January and again in March that fueled the rebound in equities so why not expect that to come to an end if the rate hikes were again put on the table? The Fed is clearly conscious of what a further tightening might do to global markets—an area which has determined its actions since last year. Let’s not forget too that the weaker US dollar since the start of the year has helped give the economy (and equities) a boost. If a June rate increase was in the cards the dollar would likely reverse course, causing equities and commodity prices to slip.

The US economy is not resource-centric like Canada, but there is evidence to suggest that the falling dollar has helped revive manufacturing. Since December the National ISM Manufacturing index has risen three straight months and is back to technical expansion territory (above 50). Unfortunately, there has only been a modest pick-up in durable goods shipments—a 0.3% rise in non-defense / ex-aircraft orders in March after sharp declines in both January and February. That doesn’t mean we won’t see a more substantial improvement in April or May, not to mention a pick-up in manufacturing employment. If so this could still sway the Fed’s decision on rates.


DXY and ISM Apr 2016


What we are missing is the possible underlying reason for lack of action on the Fed’s part. This is an election year and a critical one for the US to say the least. While the Fed is “independent” of government influence, it would be naïve to think that Fed officials are blind to the potential for interest rate increases to influence markets and the US economy months prior to the election. If true, then we may indeed be living with excess stimulus from the Fed until 2017. If the disappearance of momentum in stocks is indeed because investors see a wall of worry approaching then central banks may be playing a key, yet dangerous, role in making that wall even bigger.


Yen Apr 2016


Time for Hedges to Come Off
(Andrew Pyle, Senior Wealth Advisor and Portfolio Manager)

I have long espoused that when investors venture into foreign bonds and equities it is best to do so in a hedged manner. This means using securities that hedge back foreign exposure to Canadian dollars on a frequent (daily) basis. The reason is that while foreign investment improves the diversification of a portfolio and reduces risk, the currency market is a volatile arena that can often negate the benefits of this diversification. That said, there are times when having less hedging is beneficial, especially when currencies are reaching over-stretched limits.


CAD Apr 29 2016


This is especially true of the Canadian dollar and the Japanese yen, which have seen gains against the US dollar of 10.5% and 12%, respectively, since the beginning of the year. The Loonie has strengthened because of  a reluctance by the Bank of Canada to follow through with additional rate cuts and improved commodity prices. For the yen, it has come from a safe-haven flow by investors afraid of global economic uncertainty and belief that authorities would stimulate the economy. When the Bank of Japan refrained from adding stimulus this week the market saw that as a sign to add to bullish yen positions instead of the more realistic (bearish) take that the economy is not doing that great after all.


TSX vs Dow from Apr 29 2015


The fuel for both currencies appears to be running out as the Loonie flirts with 80 US cents and the yen approaches Y105—the strongest since October 2014. These are key levels in my opinion and should start to garner the attention of the Bank of Canada and Bank of Japan. Hedge funds looking to repair their battered returns so far this year may start to reverse bets on both currencies and this time their macro bet might pay off. For retail investors it might also be a cue to reduce hedged plays on US bonds and equities. Of course, if the US dollar does stage a comeback then it would be a cue to pull back from commodities as well. This signal is close at hand in my opinion and before we get into June it would be prudent to re-evaluate whether to start incorporating US dollar positions back in the portfolio.


Keeping Your Debt in Check
(Emily Downie, Senior Associate)

One of the important pages in a Financial Plan is the Net Worth Statement. This statement reflects the assets and liabilities of the individual.  Any assets that a person owns are listed and the liabilities are subtracted from these with the outcome being the net worth.  A financial plan is always a work in process and needs to be reviewed regularly.  It is dynamic and evolves- like life.  As an individual or couple accumulates more assets, the idea is that the net worth increases. In today’s debt laden society, however, the net worth is not always increasing and retirement can remain looming in the distant future. One of the ways to tackle this head on is to identify goals and strategies and to prioritize expenditures.

A budget can help to gain control over savings and expenses.  Listing payments and by developing a budget, there are opportunities to reduce discretionary expenses and perhaps non-essential expenses. By preparing a budget and calculating monthly expenses one of the items to address is to place the debts with the highest interest rate at the top of the list.  For individuals who may be on the brink of significant household debt, an increase in interest rates can turn catastrophic. By chipping away and paying off the debts with the highest interest rate, balances are reduced and debt can remain manageable.  Evaluate any decisions to incur new debt and remember that taking on more debt for big-ticket items that depreciate in value  will not contribute to the net worth bottom line. For any major purchases work on saving as much as possible to put towards the purchase.

Another tip is to keep an emergency fund to fall back on if any issue arises.  This emergency fund should be large enough to handle a job loss or at the very least be sufficient to pay your debts and not fall back on credit to fund lifestyle expenses. The rule of thumb is that the emergency fund should cover expenses for six months to one year.  The bottom line is that managing debt is a simple concept but can prove to be a challenging practice. Assessing spending patterns and taking the time to focus on budgeting and paying down debt will pay off tremendously in the long run.  Turning to planners and professionals to assist with this process will improve the path to financial confidence and a sound financial future.


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