When the stock market falls precipitately on low volume, market commenters like to say that the equities are suffering from a "buyers' strike". Well, it feels like sellers were on strike this week, with both the TSX and S&P rising to new highs. Aside from the low volume, what is so particular about this week's advance is the shallow intra-day volatility. Dog days of Summer or conviction at the beach? It could also be that investors awaited Fed Chairwoman Janet Yellen's speech in Jackson Hole where they did not learn much compared to what they already knew: that the Fed could act sooner rather than later if the labor market keeps improving. But how much improvement is needed remains a mystery given that Dr. Yellen tracks a bouquet of labor-market indicators. Thus, the guessing game will continue for a while.
This week, we want to bring investors' attention to the divergence between equities and credit. Over the past two years, there have been five shallow market corrections where stocks eventually rebounded and charged to new highs. As our Chart of the Week shows, each time, corporate bond yield spreads tightened through the recovery and corroborated the stock market rebound. Not this time around! Stocks are pushing to new highs while credit spreads keep widening. What are the risks that credit investors perceive which do not show on equity investors' radar?
Regarding economic statistics this week, in Canada, both headline (2.1%) and core inflation (1.7%) slowed in July, notably on lower gasoline prices. Despite soaring retail sales in June (+5.9% Year over Year), contained inflationary pressures militate in favour of a continued accommodative stance by the Bank of Canada and a weaker Canadian dollar. In the US, headline (+2.0%) and core inflation (1.9%) also moderated. Other good news: the housing market is showing signs of life again. Thanks to falling mortgage rates, new home sales jumped 15.7% in July. Also, housing starts, building permits and existing home sales all grew above consensus estimates. To close the loop, US Markit flash PMI (Purchasing Managers’ Index) (58) and the index of leading economic indicators (+0.9% Month over Month) confirm that US economic momentum is picking up. Elsewhere, however, things do not look as rosy. In Europe, the flash PMI dropped to a 13-month low (50.8), dragged down by weakness in Germany (52 from 52.4) and France (46.5 from 47.8). Obviously, the European Central Bank policy should diverge from the Fed for a while longer and keep the Euro under pressure. Europe will not complain, as exports remain constrained by Russian bans. In China, waning home price inflation is reflective of a still-weakening housing market. Meanwhile, manufacturing activity also slowed down, with the flash PMI dropping from 51.7 to 50.3 despite a sharp drop in interest rates Year To Date. As such, a consensus is developing around the possibility of a rate cut by the Peoples Bank of China this Fall.
Next week, our focus will be on Q2 GDP growth in Canada, US durable goods orders, Personal Consumption Expenditures inflation (preferred Fed gauge) as well as personal income and spending. Otherwise, we will watch inflation in Europe and in Japan.
Locally, last night was the third annual Diner en Blanc Vancouver. The annual tradition that first began in Paris 25 years ago sees thousands of people come together for an extravagant summer picnic at a location kept secret until the last minute. This year 3,200 people dressed head-to-toe in white descended onto Yaletown’s David Lam Park for the sold-out event. Want to go next year? Well there are 30,000 people on the waiting list and guests can get tickets only by knowing a previous attendee.
The forecast looks good for the short term, so we hope you’re able to take advantage of the tail-end of summer. Have a great weekend.
Thank you for your trust.
As always, we welcome any feedback.
The Dekker Hewett Group