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The economic data tends to be more supportive of stock market strength going forward as we are starting to see a ‘synchronous global expansion’ (i.e. all regions participating) for the first time in almost a decade. The U.S. economy has moved back into a recovery mode after slipping into negative territory in the first quarter, while the European economies have clearly moved into recovery mode. The weaker results recently had come emerging economies, which saw forced austerity as the U.S. dollar rose in value and countries such as Turkey, Indonesia, Russia and regions of South America had to raise interest rates to hold on to foreign capital. But now we are starting to see better data come out of the developing economies as shown below in the chart of the Economic Surprise Index for both the U.S. and the Emerging Markets. While the U.S. numbers started to turn up again following the downturn due to the severe winter weather, the data from the Emerging Economies has only started turning up in the past month.
While this data can be extremely volatile, the indicators from the larger developing economies seems to be stabilizing. The new government in India has increased optimism about the economic outlook there while Russian seems to have avoided a significant downturn in growth due to the Ukrainian situation. China has seen its economic data turn higher again while Turkish stocks have rallied almost 30% in the past three months!
Probably the biggest beneficiary of an upturn in global growth is Canada! Canadian stocks were one of the big winners coming off the lows in 2009, but then stalled and reversed two years later when the Euro-crisis hit, as commodity prices fell on worries about global growth. While Canadian stocks have recovered sharply this year and are now trading within a few points of the all-time highs set back in 2008, the road back to those highs have taken much longer here. The S&P500 Index in the U.S. and the DAX in Germany both surpassed their prior peaks over a year ago while the MSCI Global Index hit a new high at the end of 2013. While the Canadian stock market appears to have been ‘last to the party,’ we are drawing the attention of global investors. The chart below shows Net International Investment Flows for Canadian debt (bond) and equity (stock) securities. While our solid economic performance and banking system strength during the financial crisis in 2008 lead to significant foreign purchases of Canadian bonds over the past five years, stocks were less popular, with the market seeing net redemptions by foreign investors in 2013. Those trends appear to have reversed in the past six months as foreign bond purchases have dropped sharply while stock purchases have picked up.
The most significant buying appears to be in the Energy sector, where U.S. and European investors are stepping back into Canadian oil and gas stocks as the spread between global oil prices and Canadian heavy oil (WCS Select) have narrowed and natural gas prices have surged. There also seems to be less reluctance to invest in the oil sands producers in Canada, which had seen major selling over the prior few years due to the poor view that foreign investors had about the environmental impact of those projects. Financial stocks, particularly the Canadian banks, also saw net buying following the aggressive selling (and even shorting) of banks by foreign investors last year on the belief that the Canadian housing market was on the verge of collapse and that the banks would be the group most impacted by that. Our housing market appears to have survived that scare, which brought buying back into the Canadian bank stocks as well.
The financial crisis got started in the U.S. housing market as borrowers feasted on all types of new credit instruments and lax lending standards to accumulate record debt levels. Home buying by speculators helped drive annual U.S. housing starts to record levels of close to 2 million homes, in an economy where annual household formation (and, hence, housing demand) was around 1.4 million. This created massive over-supply which ultimately lead to the collapse of the housing market and the banking crisis which, in turn, set the table for the global economic crisis that followed. The chart below shows that a lot has happened since those dark days back in 2008. Not only have consumer debt levels come down (from over 135% of ‘disposable income in 2007 to under 110% today) but the cost of servicing this debt has also fallen due to the fact that interest rates have fallen to all-time lows.
This has effectively put more money into consumers’ pockets to spend in other areas of the economy, although higher gasoline prices are clawing back some of those gains. This ‘debt retrenchment’ over the past few years also explained why the economic recovery had been so lacklustre compared to prior recoveries; consumers were directing much of their excess income to paying down debts rather than new spending. With debt levels back to more ‘normal’ levels, we should start to see a pick-up in spending, which would add further fuel to the economic recovery.
Of course we have to point out that this data all refers to consumer debt loads. While consumers have been retrenching over the past seven years and reducing debt, the government has taken over and being the big borrower, amassing total debt in excess of US$15 trillion!
The bottom line is that we remain long-term bulls on the stock market due to a growing global economy, low levels of long-term interest rates and a secular increase in corporate profitability. However, stocks have had a tremendous recovery over the past five years and investors seem to be oblivious to risk to almost the same degree they were in 2007 while the sentiment levels have gotten to levels which we could almost describe as ‘giddy.’ More importantly though, when we go through our stock lists we are not seeing the tremendous buying opportunities that we had been seeing over the past few years. Sure, stocks might rise further in the short-term but we think it’s time to be a bit more prudent and take some profits in the Energy, Financial and Technology sectors. We would then look to add back to these positions on a 5-10% pullback in prices. Buyer beware!
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