Asset Allocation Strategy

Transcription

1 October 27, 2014 Asset Allocation Strategy Since the beginning of September 2014, the Economic Research and Strategy team has been recommending to overweight equities and underweight bonds. We also advised that investors maintain some liquidity in their portfolios in order to take advantage of any market correction that could likely occur on the stock market in the near-term. We initially identified concerns about interest rate increases by the Federal Reserve as a potential trigger for such a correction. These concerns temporarily materialized but quickly gave way to fears that global economic growth would slow. Indeed, the IMF downgraded its growth forecast for the global economy two weeks ago (from 4.0% to 3.8% for 2015). The downgrade was especially significant for the euro-zone with the IMF even invoking an elevated likelihood of a recession. This announcement, though not really surprising, appears to be a major reason behind the market correction seen in the last two weeks. Following these two events, financial market volatility, which had been very low until then, rose dramatically. Nervous investors then dragged down major stock markets by around 10%. Since then, despite persisting concerns, some of the ground lost has been regained and bond yields are trading at a lower level than at the beginning of September. Therefore, government bonds performed better than equities during this time. We are still recommending investors to overweight equities and use some of the cash on hand to increase or implement this overweight position. As Europe and Japan had already announced expansionary monetary policies to deal with their sluggish economies and the risks of deflation, we also expected the U.S. dollar to appreciate against the Euro and Japanese Yen. We had also forecasted that the Canadian dollar would appreciate against these two currencies but depreciate against the U.S. dollar. Soft natural resources prices and expectations of a softer tone in Canadian monetary policy in comparison to the U.S. led us to forecast that the loonie would end 2014 under the 90-cent mark. These forecasts are proving true so far, even though the Yen and Euro have recovered slightly in the last two weeks. We recommend holding a more neutral position against these currencies as much of the price adjustment has already occurred in the near-term. These price adjustments could persist next year, however. As for equities, we recommended to overweight U.S. and emerging markets. For emerging markets, we advised avoiding commodityheavy markets such as Russia and Brazil, at least until the inventory surplus seen in some markets are absorbed. We are maintaining these recommendations. We are also maintaining our recommendation to underweight Canadian equities due to their large exposure to the resource and energy sectors, as well as European and Japanese equities, where weaker growth could hurt returns. In, we recommend real estate investment trusts (REITS), which had corrected sharply on the expectations of interest rate increases in the U.S. Although these expectations did not materialize, REITS are still trading at very attractive levels. We would favour REITS that have below than average debt-to-equity ratios and offer good liquidity. These highquality securities can be an excellent alternative to more traditional fixed-income products. As for our recommendation to overweight U.S. equities, we also advised investors to favour U.S. banks a few weeks ago. Moreover, we currently added large U.S. pharmaceutical companies to our list of sectors to overweight, while avoiding the biotechnology sector. In the U.S. industrial sector, we still recommend industries and companies with greater-than-average exposure to the U.S. economy, which is seeing a relatively stronger and more sustained recovery. We recommend investors wait for further evidence that the global economic environment, outside of the U.S., is improving before increasing exposure to industries and companies more heavily exposed to foreign economies. Lastly, due to the Ebola crisis, we had recommended underweighting the airline sector. Following our recommendation, airline stocks suffered a severe correction. However, a steep drop in crude prices as well as the release of third quarter better-thanexpected results from major airline companies allowed the sector to recoup the ground lost during the correction. Yet, we reiterate our recommendation that investors distance themselves from this industry as the risk from a potential Ebola outbreak is difficult, if not impossible, to quantify. In order to still benefit from our expectations for relatively stronger economic growth in the U.S., we recommend investors to switch their exposure to the airline industry in favor of specialty retail and road & rail industries. These industries could also benefit from the drop in oil prices. Indicators to Watch For obvious reasons, it is important to monitor global economic trends, especially in Europe, Japan and China. Since the IMF downgraded its forecast for global growth last week, these are the regions investors are most concerned with. 1

2 We are also paying close attention to central bank statements. Taking into account increasing fears of a global economic slowdown, it is necessary for central banks to maintain their commitment that monetary policies will remain accommodative in order to appease market concerns seen over the last two weeks. China and Japan have already signalled their intention to adopt growth-oriented policies. As for the euro-zone, the situation is more complicated even though the European Central Bank President, Mario Draghi, seems ready to take action by implementing measures that will favour credit growth. Credit conditions appear to have slowly improved in the past few months. Indeed, for the first time since 2007, fewer European banks are reporting a tightening of credit standards for enterprises than those reporting an easing. As can be seen in the chart below, this net percentage has been a good leading indicator of economic growth in the past few years Net % of Euro Area Banks Reporting a Tightening of Credit Standards for Enterprises vs. Euro Zone Real GDP Growth (%) Net % of Euro Area Banks Reporting A Tightening of Credit Standards for Enterprises over the past three months (LHS) Euro Zone Real GDP Growth (%YOY RHS) Source: LBS Economic Research and Strategy, ECB Bank Lending Survey, Bloomberg Yet, there is still much to be done for a lasting recovery to take place; finance ministers of euro-area countries will have to agree on a fiscal stimulus package that will align with the accommodative monetary stance. Germany is currently opposed to such an idea, but we expect a compromise to be found in the short term. Any credible statement to this effect would help ease downward pressures on equity markets. As for the Fed, despite seemingly contradictory statements from different officials at times, it is preparing for a modest interest rate hike cycle. However, FOMC leaders have already signalled to market participants they would postpone these increases, if the need arises. Our call is for three increases of 25 basis points in the second half of 2015, which would bring the target range for the federal funds rate to 0.75% 1.00% by late As for, we will pay close attention to future changes in the price of oil and resources considering that the commodity sector is one of the most heavily weighted sectors in the S&P/TSX Composite index. In the short term, since crude prices have not stabilized yet, we expect that Canadian equities will continue to underperform On a positive note, periods of declining oil prices are often followed by periods of relatively high growth in equity prices (see attached table). The table also shows that U.S. equities tend to outperform Canadian equities in the twelve months following a YOY decline in oil prices; very probably because the U.S. economy derives greater benefits from falling crude prices. This is another factor behind our recommendation to overweight U.S. equities. From a more technical standpoint, we are also keeping a close eye on the relative performance of strong balance sheet stocks. Historically, companies with sound balance sheets tend to be favoured during rough times. However, their outperformance tends to diminish close to market troughs. This is exactly what we have seen in markets over the past few days (see chart below). 0,82 0,81 0,8 0,79 0,78 0,77 0,76 0,75 0,74 0,73 Relative Performance of Strong Balance Sheet Stocks against Weak Balance Sheet Stocks vs. S&P 500 Goldman Sachs Strong Balance Sheet Basket to Weak Balance Sheet Basket Ratio (LHS) S&P 500 (RHS Inverted) Source: LBS Economic Research & Strategy, Bloomberg Lastly, market sentiment turned negative very quickly during the past few weeks. One of the market sentiment indicators we closely monitor, the forward price-to-earnings ratio divided by the CBOE Volatility Index, even reached levels similar to those it was trading at during past recessions and financial crises (see chart below). However, the current economic backdrop is very much different. This led us to conclude that investor sentiment had gotten too negative and it would not take much for investors to be positively surprised. This appeared to be the case with stocks rallying since the middle of last week. 1,6 1,4 1,2 1 0,8 0,6 0,4 0,2 0 S&P 500 Forward Price to Earnings Ratio divided by CBOE Volatility Index (VIX) S&P 500 = 1,920 (October 21st) S&P 500 = 1,822 (October 15th) Luc Vallée, Ph.D. Chief Strategist Eric Corbeil, M.Sc., CFA Senior Economist October 27,

3 %YOY Change in WTI Crude Oil Price vs. 12 mth Forward Performance of different Economic & Financial Indicators ( ) 12 mth Forward Average Performance (%) %YOY Change in WTI U.S. Real GDP (%YOY) S&P 500 EPS (%YOY) S&P 500 Index S&P/TSX Composite Index Rise of more than 60% Rise between 40 to 60% Rise between 20 to 40% Rise of less than 20% Decline of no more than 20% Decline of between 20 to 40% Decline exceeding 40% Source: LBS Economic Research, Bloomberg October 27,

4 North American Forecasts q/q saar (unless otherwise indicated) Annual Average Q4/Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q Real GDP Consumption Business investment Non-residential structures Machinery and equipment Residential construction Government spending Exports Imports Inflation Total CPI (y/y % ) Core CPI (y/y % ) Unemployment rate (%) * Employment Housing starts (in 000s) * Corporate profits (y/y %) Nominal GDP *Average rate for the period. Updated: October 2014 Interest and Foreign Exchange Forecasts Historical Data Q4 14Q1 14Q2 14Q3 14Q4 2015Q1 15Q2 15Q3 15Q4 16Q4 Overnight Rate Target Month Treasury Bills Year Bond Year Bond Year Bond Year Bond United States Federal Funds Rate Target** Month Treasury Bills Year Bond Year Bond Year Bond Year Bond Canadian Dollar (US$/C$) Quarter-end data and annual av erages Updated: October 2014 * upper bound of the target range for the Fed funds October 27,

5 Market Review : Bonds and Currencies INTERNATIONAL BONDS Benchmark 2-Year Yield Yield (%) Oct week -4 weeks -1 quarter - 1 year Jan U.S Spread US Germany France Portugal Spain Belgium Netherlands Italy Switzerland UK Australia Japan INTERNATIONAL BONDS Benchmark 10-Year Yield Yield (%) Oct week -4 weeks -1 quarter - 1 year Jan U.S Spread US Germany France Portugal Spain Belgium Netherlands Italy Switzerland UK Australia Japan PROVINCIAL BONDS Benchmark 10-Year Yield Current Spreads (b.p.) against Oct Oct week -4 weeks -1 quarter - 1 year Jan Alberta British Columbia Prince Edward Island Manitoba New Brunswick Nova Scotia Ontario Quebec Saskatchewan Newfoundland & Labrador Currencies CURRENCIES Oct week -4 weeks -1 quarter - 1 year Jan (%) (/US$) (US$/) Australia (Australia/US$) U.K. (US$/ ) Japan (US$/Yen) Euro (US$/Euro) Mexican Peso (Peso/US$) Brazilian Real (Real/US$) Chinese Yuan (Yuan/US$) Data updated as at: 23/10/2014 October 27,

6 Market Review : Fixed Income Charts % 6.0 Yield on 3-Month T-Bills % 6.0 Yield on 10-Year Federal Bonds U.S U.S Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 % - Yield Curve % U.S. - Yield Curve Oct-14-1 month -1 year Oct-14-1 month -1 year m 6m 2y 5y 10y 30y 0.0 3m 6m 2y 5y 10y 30y Yield Spreads in basis points ( minus U.S.) 20-Oct-14-1 month -1 year 3m 6m 2y 5y 10y Jul-12 Oct-12 Jan-13 Spreads on 2-Year Federal Bonds (Can-U.S., basis pts) Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 October 27,

7 Market Review: Stocks Exchange and Commodities Stock Market Summary Level Change (%) Oct w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan S&P/TSX 14,338 15,658 13, S&P/TSX S&P/TSX Small Cap Index United States S&P 500 1,904 2,011 1, Dow Jones 16,400 17,280 15, Nasdaq 4,316 4,598 3, International U.K. - FTSE 100 6,267 6,878 6, Germany - DAX 8,718 10,029 8, France - CAC 40 3,991 4,595 3, Japan - Nikkei ,111 16,374 13, Hong Kong - Hang Seng 23,070 25,318 21, Russia - RST 1,045 1,519 1, Australia - ASX All Ordinaries 5,307 5,657 5, Brazil - Bovespa 54,303 61,896 44, S&P/TSX Sector Summary Level Change (%) Oct w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan S&P/TSX 14,338 15,658 13, Energy Materials Industrials Consumers Discretionary Consumers Staples Health Care Financials Information Technology Telecommunication Services Utilities Commodities Level Oct w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan London -- Gold (US$/once) London -- Silver (US$/once) Copper (US$/LB) WTI Crude Oil (US$/barrel) Natural Gas (Henry Hub) (US$/MMBTU) Data updated as at: 23/10/2014 October 27,

8 Calendar of Major Economic Indicators KEY ECONOMIC INDICATORS WEEK OF OCTOBER 20, 2014 Date Time Release Unit Data for: LBS * Consensus Previous Oct 20 8:30 Wholesale Sales M/M August % -0.2% Oct 22 8:30 Retail Sales M/M August -0.3% 0.0% -0.1% Oct 22 8:30 Retail Sales Less Autos M/M August -0.1% 0.2% -0.6% Oct 22 10:00 Bank of - Overnight rate - Oct % 1.00% 1.00% * Laurentian Bank Securities Forecast Consensus from Bloomberg L.P 10/17/2014 United States Date Time Release Unit Data for: LBS* Consensus Previous Oct 21 10:00 Existing Home Sales Millions September Oct 21 10:00 Existing Home Sales M/M September - 1.0% -1.8% Oct 22 8:30 Consumer Price Index M/M September - 0.0% -0.2% Oct 22 8:30 Consumer Price Index Y/Y September - 1.6% 1.7% Oct 22 8:30 CPI Ex. Food & Energy M/M September - 0.1% 0.0% Oct 22 8:30 CPI Ex. Food & Energy Y/Y September - 1.7% 1.7% Oct 23 8:30 Initial Jobless Claims Thousands Oct Oct 23 10:00 Leading Indicators - September - 0.7% 0.2% Oct 24 10:00 New Home Sales Thousands September Oct 24 10:00 New Home Sales M/M September % 18.0% Consensus from Bloomberg L.P 10/17/2014 October 27,

9 North American Economic Indicators CANADA Period Monthly Chg. (% or Level) Cumulative change Current Previous - 3 Month - 1 Year Gross Domestic Product (GDP) July 0.3% 0.3% 0.9% 2.5% Manufacturing Shipments July 2.9% 1.0% 5.7% 8.5% Housing Starts ( ' 000) * August Retail Sales July -0.1% 1.2% 1.9% 5.0% Trade Balance (M$) * July 114 1, Employment ( ' 000) * * September Unemployment Rate * September Wages (avg. hourly earnings) September 2.1% 2.5% 1.4% 1.9% Total CPI inflation September 2.1% 2.1% 2.3% 0.7% Inflation ex-food & energy September 2.0% 2.0% 1.7% 1.2% Industrial Product Price Index (IPPI) August 0.2% -0.3% 0.0% 2.5% IPPI ex. energy August 0.2% 0.3% 0.5% 2.9% UNITED STATES Period Monthly Chg. (% or Level) Cumulative change Current Previous - 3 Month - 1 Year ISM - manufacturing * August ISM - Non-manufacturing * August Industrial Production * August Capacity Utilization Rate * August Consumer Confidence Index * September Retail Sales August 0.6% 0.3% 1.3% 5.0% Trade Balance (M$) * July -40,321-40,810-45,977-39,515 Housing Starts ( ' 000) * August 957 1, Existing home sales August -1.8% 2.2% 2.9% -5.3% Median price of ex. home sales August -1.4% -0.2% 3.0% 4.1% Non-Farm Payrolls ( ' 000) * * August Unemployment Rate * August Wages (avg. hourly earnings) August 2.5% 2.3% 2.4% 2.1% Total CPI inflation August 1.7% 2.0% 2.0% 1.5% Inflation ex-food & energy August 1.7% 1.9% 1.9% 1.8% Producer Price Index August -0.4% 0.1% 0.3% 2.2% - Ex-Food & Energy August 0.1% 0.1% 0.4% 1.9% * Level, * * Change in level for the last month, 3 months and 1 year, * * * Annual % change Data updated as at: 23/10/2014 This document is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of Laurentian Bank Securities (LBS), a wholly owned subsidiary of the Laurentian Bank of. The author has taken all usual and reasonable precautions to determine that the information contained in this document has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze it are based on accepted practices and principles. However, the market forces underlying investment value are subject to evolve suddenly and dramatically. Consequently, neither the author nor LBS can make any warranty as to the accuracy or completeness of information, analysis or views contained in this document or their usefulness or suitability in any particular circumstance. You should not make any investment or undertake any portfolio assessment or other transaction on the basis of this document, but should first consult your Investment Advisor, who can assess the relevant factors of any proposed investment or transaction. LBS and the author accept no liability of whatsoever kind for any damages incurred as a result of the use of this document or of its contents in contravention of this notice. This report, the information, opinions or conclusions, in whole or in part, may not be reproduced, distributed, published or referred to in any manner whatsoever without in each case the prior express written consent of Laurentian Bank Securities. October 27,