Keep connected
Our investment management team is made up of engaged thought leaders. Get their latest commentary and stay informed of their frequent media interviews, all delivered to your inbox.
It was a ‘Tale of Two Markets’ in October as stocks entered the month on a soft note and proceeded to fall precipitously over the following two weeks. At their lows on October 15th, the TSX Composite Index and the S&P500 were down 12.5% and 9.9%, respectively from their early September all-time highs, fixed firmly in correction territory. Just as quickly as the market fell, it began to recover over the final two weeks of the month with the S&P500 finishing with a gain of 2.3% to an all-time high. Extreme weakness in oil and gold stocks kept the Canadian market from making as strong a recovery as the S&P/TSX Composite Index still fell by 2.3% on the month, hurt by a 10.9% drop in the heavyweight Energy sector and another 11.5% fall in the ‘gold-laden’ Basic Materials sector. A snapshot of global stock market returns for the month of October and year-to-date is shown in the table below.
The most telling insight, in our view, is that in Canada the smaller stocks have seriously lagged the performance of the larger, more stable names. The resource sector has been hit particularly hard as a stronger U.S. dollar has been putting downward pressure on almost all commodity prices. Europe has also been one of the laggards as well due to worries about the economic slowdown this year, the greater risks from the Russia/Ukraine conflict and the uncertainty about how aggressive ECB Chief Mario Draghi will be in reducing interest rates further and putting some bond-buying programs into effect, similar to the QE program that just ended in the U.S.
Bond prices continued to work higher as worries about economic growth kept interest rates low. For the month, the FTSE Bond Index in Canada gained 0.57% and is up over 6.5% so far in 2014, lead in large part by the 12.5% gain in 30-year government bond prices. The U.S. Federal Reserve is the only major central bank making any sort of ‘policy tightening’ moves as they ended their Quantitative Easing (QE) program in October but still left the door open for further accommodation down the road ‘depending on the economic data.’ They are the most ‘hawkish’ of all the central bankers as the rest, including Canada, have made absolutely no reference to tightening money policies in the foreseeable future. In fact, Japanese central bank head, Gov. Haruhiko Kuroda fired off a fresh round of ammunition from his famed money-spewing bazooka, shocking markets with a big increase in the central bank’s stimulus program. The impact was immediate, with the Nikkei Stock Average soaring more than 4% and the yen dropping sharply to a near-seven-year low against the dollar. They stunned the financial world by sharply ramping up their own version of the QE scheme, adding to its purchases of bonds and stocks, while that nation’s pension fund said that it would shift its portfolio holdings away from bonds and toward stocks. Once again, the prospect of easy financial conditions is being used to fuel the fire of stronger asset prices.
For almost six years, one of the most powerful bull markets on record has coexisted with the weakest economic recovery since World War II. The early month selloff in stocks shows how quickly investors can get nervous about the sustainability of such a situation. Market volatility soared to a three-year high and the Standard & Poor’s 500 Index dropped as much as 9.8 percent in the 26 days ending Oct. 15th, before recovering into month-end. From March 2009 through June 2014, the S&P 500 has increased 4.7 percent a quarter, about five times faster than gross domestic product, data compiled by Bloomberg show. That’s the biggest gap since at least 1947!
This means that the bulk of the gains in stock prices have been due to placing a higher multiple on earnings, as opposed to being because of higher corporate earnings, the preferred method. While stocks were cheap at the bottom of the market in 2009, we can no longer make that argument today. Record low interest rates have engendered a period of higher stock valuations supplemented by record levels of corporate stock buybacks, many of which were funded by the issuance of corporate bonds. While we are still a long way from the ‘nosebleed’ levels of the late 1990’s, we continue to worry that a stock market sustained by low interest rates and rising valuations is much more susceptible to disappointment if economic growth starts to slow down.