Stocks moved higher again in February, with the S&P/TSX Composite in Canada and the S&P500 index in the U.S. each gaining about 1.3%.  But the joy wasn’t necessarily that widespread.  There was a high level of volatility and the gains were confined to a smaller group of large stocks, including the financials and the consumer stocks.  The RBC ‘style indices’ reflected this difference in both the U.S. and Canada as the Predictability index rose 2.7% while the Momentum, Value and Growth Indices all rose much less.  The difference was also apparent in Canada in the size indices, where the large stock S&P/TSX60 index gained 1.7% while the smaller stock S&P/TSX Completion index gained only 0.1% and the S&P/TSX Small Cap index fell by 3.0%.  Investors seem to be saying that they want to buy stocks but that they don’t want to increase risk too much so they are sticking to the biggest and safest names with the best earnings predictability.

In terms of global stock sectors last month, the trend of the past year continued with the non-cyclical sectors leading the way.  Consumer Staples gained 1.9%, Industrials were up 1.5%, Media up 1.1% and Health Care added 0.7%.  On the downside were the resource-related sectors including Basic Materials down 3.3% and Energy falling 2.6%.  This reflects the same risk aversion mentioned earlier and is typical for the early part of any market advance.  As investors become more comfortable with the outlook for the economy and the idea of moving back into stocks, the risk levels also tend to increase and this leads to better performance from the more ‘cyclical’ or ‘economically sensitive’ sectors of the market.   Later in the cycle is when the smaller stocks start to participate more aggressively since their valuations tend to be that much more attractive and the growth potential that much higher.  Clearly we have not reached that point in the cycle yet!

Bond prices also moved higher last month as well with interest rates falling from recent recovery levels.  The DEX Bond Universe showed a gain of 1.00% in February after falling 0.7% in January.  Corporate bond and mid-term government bonds showed the best relative gains.  The Canadian dollar is off 4.1% versus the U.S. dollar since the start of 2013.  This CAD/USD shift marks an important reversal following a decade of near constant appreciation. It appears that weaker economic fundamentals in Canada versus the U.S. (housing, retail spending) could continue to take the C$ lower in coming months.  As long as the drop is not precipitous and doesn’t shake foreign investor confidence, there should be some benefits to Canadian export-oriented companies, though, as they get an earnings pick-up from the currency decline.

The economic data continued to be good last month, particularly the manufacturing and housing data from the U.S.  China was slower in February due to the annual Spring Festival while the numbers from Europe continued to be soft, although the worst part of the downturn seems to be passing, particularly in Germany.  All the monetary stimulus over the past five years finally seems to be taking hold; consumer debt levels are being reduced, companies are flush with cash and investment spending is picking up again.  The recovery in the housing market in the U.S. is very important since housing represents the largest investment for most households; people feel better about increasing their spending if employment if increasing and the value of their home is rising (or at least not falling anymore).  The red line in the chart below shows the Global PMI (purchasing managers’ index) for manufacturing.  A number above 50 (left scale) indicates economic expansion; while the numbers were below that level early in 2012, they have been recovering since mid-year.  We have also added the CRB (Commodity Research Bureau) metal price index to the chart, which mirrors the move in the PMI fairly closely.  Our positive outlook on resource-related stocks comes from our belief that global manufacturing is on the rise again and that most of the key basic materials (met coal, copper, lumber) all remain in relatively tight supply, meaning that prices should rise as demand increases.

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