Stocks in 2016 have been “A Tale of Two Markets”, going from the ‘worst of times to the best of times’ as the recovery from the worst start to a year ever has turned into solid gains, at least in Canada, as we end the month of April.  Since Feb. 11, when the U.S. stock market pulled out of its early 2016 tailspin, the S&P500 Index has rebounded by 14%, leaving it up about 1% for the first four months of the year.  It has been dubbed a ‘reflation trade’ because it has been led by commodities, notably crude oil, which has run up more than 70% from its lows in the mid-$20-a-barrel range to the mid-$40s, and has been accompanied by a 3% drop in the U.S. Dollar Index, which has lit a fire under other commodities such as gold.  All of this helped Canada’s S&P/TSX Composite Index generate another 3.7% gain in April, lead by an 8.4% gain for the Energy sectors and a whopping 20% monthly gain for the Basic Materials group, home to the formerly downtrodden mining stocks.  The Canadian market’s 7.2% year-to-date gain is the best among the major industrialized stock markets, although it is well behind the gain of over 20% for Brazil, another resource-oriented economy coming out of a long period of stock market underperformance.

The U.S. recovery finally ran into some selling in the last week of April as technology and health care, former leaders, fell further on weak earnings reports.  While the S&P500 and Dow Jones Industrial indices eked out gains of under 1% each in April, the ‘growth stock laden’ Nasdaq Index dropped 1.5%.  However, despite the recoveries, most global stock indices remain in negative territory so far in 2016, particularly those in Europe and Asia.

Canada outperforming in 2016

After the big rally we have seen in the cyclical/resource sectors of the market, we have to decide if we have seen the bottom in these stocks or whether we have just experienced another ‘bear market rally’ which we should be selling/shorting into.  As we now head into the “Sell in May and Go Away” seasonal trade, the direction of these stocks will continue to be driven by the moves in the trade-weighted value of the US dollar (traded as the DXY).   Commodity stocks have not risen because the global economic outlook is suddenly much better.  In fact, the U.S. numbers have been slipping again, Europe remains in slow growth mode and Japan has slid back into a recession, along with the larger emerging economies such as Russia and Brazil.  In the end, it has been the US$ that has played such a crucial role in pushing up risk assets.  The DXY has now fallen back to its key support level in the 92-93 range.  If it fails to break below this support, a rebound could trigger profit-taking activities in commodities, Canadian stocks and the Canadian dollar.  But why is the U.S. dollar under pressure?  The clear breakdown started over two months ago when investors started to question whether the U.S. Federal Reserve would go ahead with the four interest rate increases in 2016 that were forecast last December when they started raising rates.  The decline in the U.S. dollar accelerated in March when Fed Reserve Chair Janet Yellen came out with an ‘uber-dovish’ speech that suggested the Fed would keep interest rates lower for longer than most investors (and her associates on the Federal Reserve) expected.  So why is the U.S. Fed being so soft on interest rates?  The economy is growing, core inflation increased at an annualized rate of 2.3% in the past three months (above their targeted level of 2%) employment gains have exceeded 200k per month and unemployment claims hit a 42-year low last month!  It seems illogical that the U.S. Fed would continue to keep interest rates at crisis levels when all of their key indicators suggest moving to ‘normal’ levels.  In fact, past experience should have taught the Fed that it is much tougher to stop inflation from moving higher once it starts to take hold, meaning more aggressive rate hikes later if they fail to move now!  But the official word from the Fed continues to point to ‘global financial risks’ in defense of their low interest rate policies.  This is a departure from past practices when global economic conditions were never part of the equation.

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