Weekly Capital Strategy – October 21, 2016
Any More Doubts That Bank of Canada Wants a Cheap Loonie?
This week’s Bank of Canada meeting was supposed to be a rather boring affair, with no change in rates predicted and Bank officials possibly more joyful about the latest employment stats. Instead, the accompanying policy statement talked of more challenges to housing and exports. The shift in language wasn’t a big deal, but the words that uttered by Governor Poloz’s mouth in the Q&A cemented a course for a weaker Canadian dollar.
We have known for some time that the Bank of Canada prefers to get its economic stimulus from currency depreciation as opposed to the bazooka approach through quantitative easing employed by other central banks. The platform produced some benefits into the early part of this year as the Canadian dollar slumped below 70 US cents, however, the effect was short-lived as the currency rebounded back to 80 cents before the summer. The pop was short-lived as the Loonie dropped about 4 cents in May, but continued weakening was thwarted by a revival in crude oil prices in June. While there was increased anxiety following the June Brexit vote and a subsequent retreat in oil back to $40/barrel, the Bank did not see the currency push appreciably below 76 cents throughout the summer.
In the first week of this month the Loonie made an attempt at 75 cents, but found support and pushed close to 77 cents before this week’s policy meeting. The was no surprise in this move as excitement over potential OPEC production cuts has taken crude oil north of $50 again. I still believe that we have more bad news on the oil price front before we enter a period of truly balanced supply and demand, but it is clear that Mr. Poloz and crew did not want to take any chances. The only thing to do was talk the Loonie down and the Q&A appearance was his platform.
In his comments about growth prospects and challenges, the Governor indicated that officials at the meeting were close to cutting rates. That came as a shock to economists who thought that, if anything, the balance of risks still suggested a wait and see mode. In addition, there has been increased expectation of a Federal Reserve rate hike this December. If the revelation that officials were actually toying with a rate cut wasn’t bad enough, Mr. Poloz went on to say that negative rates are still in his toolkit (recall that the Bank of England essentially abandoned this as a possibility this summer, despite Brexit).
The tactic worked and the Loonie reversed gains Wednesday morning and dropped to near 76 cents. As traders became more convinced that a Loonar eclipse was at hand, the currency fell through this level on Thursday. Friday was the icing on the cake for Mr. Poloz as Canadian retail sales for August posted a 0.1% decline and CPI came in weaker as well. At the time of writing we had just dipped below 75 cents for the first time since March. The question now is how weak does the Bank want the Loonie and what it is prepared to do to get it?
If we look at the recovery from January to May, the 50% retracement level is just above 74 cents. From today’s perch that is easily attainable, depending on whether crude oil extends gains. If we were to see a retreat in oil, coupled with a general risk-off attitude in global equity markets, then the Loonie should be able to slide towards 72.75 cents (the 61.8% Fibonacci retracement of the first half rebound).
How to position for this is the next big consideration for investors. For one, I would expect to see Canadian bonds underperform the US after three months of outperformance (the spread between the 10yr CDN and US yields is below minus 60bps). Second, a weakening in the Loonie should benefit export-centric firms on the TSX as well as those financials where US$ revenues account for a significant share of the bottom line. I do, however, think there is a limit to CAD weakness and if do get into the low 70s, then it will be time to sell US dollar positions.
Canada Still in Front But Be Careful
We are just a week away from month-end and maybe a first snowfall. Despite the noise from the US election campaign it has mainly been an uneventful October. Equity market volatility has trended higher from the sleepy days in August, but no major spike just yet. Some elevated nervousness over Federal Reserve tightening has caused NY stocks to fade, with the major indices off close to 1-1/2% since the end of September. Elsewhere things haven’t been bad. European equities have posted a decent 2% recovery so far this month, while Japanese shares are up more than 4%.
Here at home October stock performance has been somewhere in between with the TSX up just over a percent. Most of this can be attributed to a 4.5% lift in energy shares and a reasonable 1.7% rise in financials. Given that these two sectors account for 54% of the overall TSX, the impact on the index for the month gives us a distorted picture of underlying sentiment. In fact, consumer staples and industrials are the only two other groups to show real improvement this month. For the reasons I discussed in the previous section it is natural to expect the leadership from energy and financials on higher oil prices and a weaker CAD dollar.
The problem is that both are getting way ahead of fundamentals. Valuations in the energy patch are back to where they were in June 2015, when oil was trading around $60. Financials are a whisker away from testing the all-time record highs set in November 2014. For the Bank of Canada to signal concern over a slowing housing market in the wake of new federal regulations and for the CMHC to raise an alert over the risk level in housing this past week, we have to be careful about complacency once again in the banks.
Trading revenues have been very respectable for the banks coming out of the summer and a red-hot housing market has fueled mortgage demand. A late spurt in pre-approvals will linger through October, but it is November that things could change. Leadership on the TSX may easily turn to into a drag as we head into year-end.
Some Further Insights on Charitable Giving
(Natalie Warren, Investment Associate)
I was reading the World Happiness Report published by the United Nations Sustainable Development Solutions Network the other day and I noticed that Canada was 6th on this list of 150 countries and a big part of our happiness (according to the report) had to do with our generosity i.e. the answer in the survey to the question, “Have you donated money to a charity in the past month?” was yes for many Canadians.
Part of the reason for our generosity might be that our government encourages us through tax breaks to support charities. To use your donation towards your 2016 taxes, it must be completed by Dec 31, 2016. A great option is to donate securities instead of cash with the benefit being that you will receive a non-refundable tax credit based on the fair market value of the shares donated.
In addition, the capital gains on the donated shares will be eliminated meaning that no taxes will be payable on any capital appreciation. For the above reasons, your tax benefit will be more significant when you donate securities instead of cash.
Another great reason to consider a donation of securities at this time is that we have had yet another great year in the stock market and this may be a good time to capture some of those gains while accomplishing some of your charitable goals. If the stock market were to falter, some charity close to your heart may miss out on your donation.
Another timeline to keep in mind is that the opportunity to claim the First Time Donor’s Super Credit (FDSC) ends in 2017. To qualify as a first time donor, you or your spouse should not have claimed a donation tax credit for any year after 2007. So if you were to donate $500, under the FDSC, you would have a tax credit of $242* instead of a credit of $117 as a regular donor.
This may also be a good time to review the other charitable goals that you have and how they can be structured through the use of insurance or a charitable remainder trust and similar vehicles, to maximize your gift and minimize your tax.
Please check with your tax professional before acting on any of these ideas and keep Canada high on the Happiness Report with your generosity.
*For a FDSC donation of $500, 15% x200= $30 plus 29%x$300=$87 plus $500×25%= $125. $30+$87+$125=$242.
Upcoming events
Canada: Wholesale trade, CFIB business barometer
US: Consumer confidence, new home sales, durable goods, pending home sales, employment cost index, Q3 GDP, Univ of Michigan consumer sentiment
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