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One reason why we are cautious on our view of the Canadian dollar is because we are also wary about the recent recovery in energy prices. While the price of crude oil has soared more than 50% from its low on February 11th, the price action has not signalled a rush of new bulls into the depressed commodity. Instead, the upward pressure on prices appears to have come from traders cashing out of bearish wagers at an unprecedented pace. According to the CFTC, the liquidation of short positions during the last seven weeks has been the largest on record! The rally has come from shorts getting scared out of their positions rather than a lot of money coming in on the long side. This calls into question the staying power of the rally. After adding to our oil stocks in late January, we have been reducing our positions in the current rally, believing that the fundamentals still do not support the recovery in prices.
While we see the recent sharp recovery in commodities and related stocks being mostly due to a bounce from oversold levels and a massive spurt of buying back of short positions, the rally could go further. The impetus to keep commodities and stocks moving higher would be continued weakness in the U.S. dollar, which has pulled back from the late January highs and is sitting at key support levels against its major trading partners. Supporting more weakness in the USD has been the recent, more ‘dovish’, talk from U.S. Fed Chairman Janet Yellen, who continues to point to worries about global growth, a weak U.S. recovery and low inflation as reasons to keep interest rates at what most market participants see as ‘crisis levels.’ When the U.S. Fed finally raised rates by ¼ point last December, most strategists suggested they had moved too late and that, by not normalizing interest rates now, were not leaving themselves any room to move rates lower if growth should suddenly slow down. We agree with that view and don’t see the need to keep interest rates as low as they were during the financial crisis, particularly since all this has done is to increase the value of financial assets and create the potential for a larger correction sometime down the road. The chart below shows projection for long-term interest rates by Federal Reserve members over the past four years. Despite the fact that U.S. unemployment has dropped below 5%, over 220,000 jobs are being created each month for the past year and core inflation is running at a 2.3% annualized rate over the past three months, the projection for long-term interest rates dropped to an all-time low of 3.25% at the March 16th Fed meeting.
While the Federal Reserve continues to put a backstop on stock prices with their ‘uber-low’ interest rate policy, not everyone is buying into this rally. Demand for U.S. shares among companies and individuals has been diverging at a rate that is without precedent, another sign of how crucial buybacks are in propping up the bull market. On the one hand, S&P500 Index constituent companies are poised to repurchase as much as $165 billion of stock this quarter, approaching the record reached in 2007. But these share buybacks by corporations contrasts with rampant selling by clients of mutual and exchange-traded funds who are on pace to reduce holdings by over $50 billion in the first three months of 2016, one of the biggest quarterly withdrawals ever!
