Stocks have continued to move mostly higher in April despite weaker economic numbers in the U.S. and China and negative earnings growth.  The ‘easy money policies’ of global central banks continue to embolden investors to move further down the risk curve, putting stocks at the top of the list.The MSCI World Index made a new high last week on gains in European and Asian stocks.  Energy and Financial stocks have lead the recovery in the Canadian market over the past month.  Oil prices bounced back over 20% from the January lows, which helped energy stocks start to recover some of the huge losses seen over the past year, even though the TSX Energy Index is still more than 30% below its high from June of 2014, when oil prices were still over US$100 per barrel.  Bank stocks had also suffered due to the slowdown in Western Canada and worries about their loan books.  However, bank earnings growth still looks to be slowing down due to over-extended credit conditions in Canada and some risks in the housing market.  We continue to see U.S. short sellers on the Canadian banks, suggesting that they are more concerned about the outlook than Canadians are.

In the U.S., while the S&P500 has lagged the gains made in other global markets over the past six months, it remains very close to its all-time high.  Strength in core technology stocks such as Microsoft, Google and Amazon pushed the Nasdaq Index to an all-time high, cracking through the 5045 level more than 15 years after the market reached its ‘tech bubble peak’ back on March 10th, 2000.  The good news for investors though is that this time there are much better fundamentals underlying the strength in technology stocks as the major players are all generating strong earnings growth and significant cash flow generation.  The advent of cloud services and social media have powered the gains in stocks as the companies have been able to ‘monetize’ these investments, rather than just paying for ‘eyeballs on free services’ the way they did back in 2000.  Technology stocks remain one of the few areas of the market where we still see good value.

First quarter earnings are coming in slightly ahead of expectations, but the bar was set so low that earnings will still be down year-over-year.  While the estimates had overall expectations of a 5.6% drop in S&P500 earnings for the first quarter, actual results look like they will come closer to a drop of only 2%.  But revenues are missing the expectations, with only 44% of reporting companies showing better than expected top line growth.  Moreover, expectations for the next few quarters are also being revised down in most cases as the negative impact of a stronger U.S. dollar and slower growth are moderating expectations.  Bad winter weather, lower oil prices and a stronger U.S. dollar have been the main excuse for the reduced growth for U.S. multinationals.

Greek debt negotiations are once again making the headlines as a series of major debt payments are coming due in the next six weeks, and Greece is running out of money again.  Finding a compromise between Greece and the bodies which oversee its two bailouts over required reforms is proving difficult, despite numerous meetings on the issue.  Lenders want Greece to implement far-reaching reforms to its pension and labor markets, as well as privatization programs and more cost-cutting measures, but Greece’s leftwing government, which was elected in January in large part because of its opposition to austerity, is reluctant to do so.  But time is running out for Greece if it wants to receive a last tranche of aid and avoid a potentially messy default on its loans.  It has debt repayments of $1.03 billion to the IMF due in May and has to pay its domestic wages and pension bill this month, but its slow reform drive means a last tranche of aid has not been released.  The best that these groups seem to be able to do is to ‘kick the can down the road’ each time by pushing out the financial commitments to future deadlines.  The reality is that Greece will never be able to pay back its debt in the current form.  Either the lenders are going to have to take a significant cut in their loan value or Greece is going to have to leave the ‘clubby’ Eurozone.  Investors still seem to think some type of deal will be done, another reason why we are not comfortable with the overall outlook for global stock markets.

While we remain extremely concerned about the risk in stocks right now, we are seeing similar concern from many other strategists and investors.  Goldman strategists get cautious on stock market outlook and valuation. While Goldman Sachs did report a blockbuster first quarter earnings report that beat expectations on strength in capital markets, the strategists at the firm are less bullish on the outlook for stocks as indicated in their recent market report.  They pointed out that the S&P 500 Index trades at a forward P/E of 17.2 times, the highest level in the past 40 years outside of the Tech Bubble. The median stock trades above 18 times, the highest level since 1976.  The strategists also point out that over 800 trading days have passed without a 10 percent correction for the S&P 500.  The length of the current rally without a correction has been exceeded only three times since 1930, raising investor concern that the market may be overdue for a correction in the near future.

Another typical ‘late cycle’ indicator in place for stocks is the level of merger and acquisition (M&A) activity taking place.  As economic growth and earnings increases slow down, companies turn more and more to M&A activity to supplement growth.  Investment banks are happy to facilitate the process, which is made even more attractive given record low rates of interest (for debt financing) and high valuations for stocks (giving a high-priced currency for those companies wishing to buy using their own stock).  The last two peaks in M&A activity came prior to the market peaks in 2000 and 2007.  The chart below shows how the activity has picked up again in the past year with deals totalling over US$4 trillion.  While we can’t say when the peak in this activity occurs, the risks associated with the overall stock market once we see a major pick-up in M&A is fairly obvious in the charts.

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