WEEKLY
MARKET INSIGHTS
May 8, 2015
THE LATEST MARKET INSIGHTS
FROM THE RICHARDSON GMP TEAM
Higher Yields?
Equity markets are making up some lost ground today after the U.S.
reported that the country created 223,000 jobs last month, rebounding from
a soft March, impacted but harsh weather and port disputes. The jobless
rate fell to the lowest level since March 2008. However, the area of concern
for us was that average hourly earnings rose less than expected. The data
is still encouraging enough to hold our expectations that the Fed will raise
rates before the end of the year.
The Canadian jobs data was also released today. Canada added 46,900
jobs, with a gain of 12,500 jobs in Alberta, which is quite surprising
considering that the energy centric economy has been under pressure as of
late. Digging into the data deeper, it shows that the increases are
completely attributable to part-time work, with full-time positions declining
during the month. This was likely caused by oil companies compelled to lay
off full-time employees over the past few months hiring workers back on a
part-time or on an ad hoc basis. It could also be a function of the recent
election that just took place, where boosters were needed to run all of the
campaigns, as well as support staff at Elections Alberta.
The election did not go unnoticed with the Canadian energy sector getting
hammered this week after a surprise win by the NDP party in Alberta. This
will have a meaningful impact on energy companies in the province as the
new government will review royalty rates, causing uncertainty that is sure to
weigh on stock prices. There is also going to be a hike in corporate taxes
from 10% to 12% and changes in the environmental policy, which will surely
be more onerous and costly. On a positive note, this is the first change in
government in 44 years and with it promises to bring change.
Across the pond there was also a surprising election win by the
conservative party in the United Kingdom. The government should continue
to focus on reducing the deficit, eliminating the uncertainty surrounding the
fiscal policy. Markets love political steadiness, so with David Cameron and
his party remaining in office, we would expect the U.K. market to rally higher
which it did, surging 2% on the news and closing even higher.
TSX COMPOSITE
15,500
15,300
15,100
14,900
M
o
n
T
u
e
W
e
d
T
h
u
F
r
i
T
h
u
F
r
i
S&P 500
2,120
2,100
2,080
2,060
M
o
n
T
u
e
W
e
d
Source: Bloomberg, Richardson GMP Limited
Craig Basinger, CFA
Chief Investment Officer
416.607.5221
[email protected]
Gareth Watson, CFA
Director, Investment Management Group
416.969.3161
[email protected]
Derek Benedet, CMT
Research Analyst
416.607.5021
[email protected]
Chris Kerlow, CFA
Research Analyst
416.943.6156
[email protected]
WEEKLY MARKET INSIGHTS
2
Higher Yields?
Let’s start with what the market is thinking. Current forecasts are for the
U.S. 10-year to remain about the same (2.13%) till mid-year, then begin
grinding higher to finish the year at 2.42%. We believe this will prove
too conservative. While we have been surprised by the speed of the
recent move, as it has come at a time when the economic data is, well,
dire. U.S. GDP in Q1 had an initial print at 0.2% and will likely be
revised into negative territory. The delayed impact of lower energy
prices and a higher U.S. dollar should both limit inflationary pressures.
This plus other data continuing to be soft should nip this current increase
in yields in the bud at some point. It may have been today. However,
looking down range, bond yields should rise, and we think more than the
consensus expects.
Bond yields have risen….where to now?
3.00
2.50
2.00
1.50
1.00
12/31/2013
1/31/2014
2/28/2014
3/31/2014
4/30/2014
5/31/2014
6/30/2014
7/31/2014
8/31/2014
9/30/2014
10/31/2014
11/30/2014
12/31/2014
1/31/2015
2/28/2015
3/31/2015
4/30/2015
The U.S. 10-year bond yield has climbed from 1.90% to 2.30% during
the past two weeks, before declining off today’s Labour Report back
down to 2.12%. The Canada 10-year rose from 1.30% in mid-April to
1.84%, again before declining on Labour Reports down to 1.68%. This
increase in bond yields is a material move and the speed was also pretty
quick, taking the market by surprise. It is important to note this uptick in
bond yields was not fueled by strong data in North America, but in
Europe. European bond yields reached such lows that some decent
data has sent yields screeching higher. The German 10-year moved
from 0.10% to 0.55% for example. These put upward pressure on North
American yields. So, where are bond yields going, in our view?
US
Canada
We may be getting close to seeing inflationary
pressure from the U.S. labour market
12.0
10.0
8.0
6.0
4.0
2.0
0.0
Economic data tends to swing like a pendulum around expectations.
Expectations get too high, data disappoints, and we swing the other way.
Currently, expectations have probably become too pessimistic and when
the data mean reverts, the pendulum will likely swing the other way. It is
not lost on us how the recent mini move in bond yields came with no
positive economic data. What happens when we have the data as well?
There is still slack in the U.S. economy but its fleeting. Capacity
utilization is 78%, and we have found over 80% starts to illicit inflationary
pressure, so there is a little room here. But the labour market is the
interesting element. The unemployment rate was 5.4% from today’s
labour report and has been steadily moving lower. Note that the
unemployment rate bottomed last cycle at 4.4% and 3.8% the previous
cycle. So we are getting closer. However, another interesting point is
the unemployment rate has just dropped below NAIRU. NAIRU is the
natural unemployment rate that doesn’t drive inflation. Anything below
starts to get inflationary. Currently the OECD places NAIRU at 5.45%.
-2.0
Negative
Unemployment less NAIRU
Dec-13
Dec-11
Dec-09
Dec-07
Dec-05
Dec-03
Dec-01
Dec-99
Dec-97
Dec-95
Dec-93
Dec-91
Dec-89
Dec-87
Dec-85
Dec-83
Dec-81
-4.0
CPI
Pressures building due to opening and quit rates
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Nov-09
May-10
Nov-10
May-11
Nov-11
May-12
Nov-12
May-13
Nov-13
May-14
Nov-14
Dollar and Oil, these are powerful forces on inflation and they have
been pushing inflation lower lately. But this will begin to normalize as the
move in both consolidates a bit and the year-over-year change becomes
less pronounced.
Job Openings
Quit Rate
Hires
Fires
Source: Richardson GMP Limited, Bloomberg
Sticking with labour, we have seen quit rates rise and job openings reach higher levels than last cycle. Quit rates are important
because if the labourer does not feel comfortable enough to quit and move to another job, there is limited wage pressure. Once folks
start moving around with the vast majority are moving to higher pay jobs, we start to see a tighter labour market. The sheer number of
job openings is a sign as well. Add to this, initial jobless claims at their lowest levels since 2000. This is getting tighter.
Conclusion – This run up in bond yields may be premature, but it is coming. We would be remaining shorter duration and limit interest
rate sensitivity among equities.
WEEKLY MARKET INSIGHTS
3
Chart of the Week
The recent volatility in the currency market is a reaction or
normalization to what has really been an extreme market
event. The U.S. dollar is in demand, and the increased
demand will likely continue for the foreseeable future. The
breakout in the second half of 2014 and early 2015
occurred with an incredible amount of force. It brought the
Trade-Weighted USD Index (DXY) from below 80 in July
2014 to a high of over 100 in March 2015. From the recent
high, the index is now down close to 7%. This pullback is
roughly a 30 percent retracement, still shy of the prime
Fibonacci retracement level of 38.2% which would bring
the index back down to just over 92.
USD pulling back from a near term extreme
160
150
140
130
120
110
100
90
80
70
May-14
May-12
May-10
May-08
May-06
May-04
May-02
May-00
May-98
May-96
May-94
May-92
May-90
May-88
May-86
May-84
May-82
May-80
May-78
May-76
The consolidation phase is in the midst, but of course no
60
one quite knows how far or how long it will continue. To
add some historical perspective to the recent period, in the
chart (source: Bloomberg) we have plotted two bands
15% above and below the 50-day moving average. In the past 40 years it’s only breached these bands in 1981, 2008 and 2015. In
1981, this instance occurred during the initial thrust in the multi-year bull, however before the index went on to new highs, it
consolidated back to its 50-day moving average. The second time this occurred was in 2008 when the U.S. dollar became the go-to
safe haven trade. Each time, the index breached the band only briefly before settling back down towards their moving averages. The
moving averages are trend following indicators that lag prices, the sensitivity is simply dependent on the number of trailing periods
included in the average.
Though technically the U.S. dollar has ‘broken out’, it is possible that the U.S. dollar index will retrace, perhaps all the way back to the
50-day moving average (88.27), or another 7%. It will more likely consolidate in both price and time, with probably only a few more
percentage points on the downside. As this happens both commodities and companies with a large global presence will reap the
benefits. The pullback in the dollar should also ease the deflationary pressured in the U.S.
Through last Thursday's close, the index recorded six consecutive daily losses. This is just another example of a crowded trade gone
wrong. On a relative basis, the Canadian dollar may strengthen a little more, but we still view it as a counter trend move, which could
prove to be difficult to trade around. We expect to see a continuation of the loonie’s decline relative to the U.S. dollar in the second half
of this year. If the Canadian dollar continues to appreciate materially, we should be on guard of another Bank of Canada cut, as they
have projected that this is not what they want at the moment.
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