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Summary
- Stocks in Canada fell again in July as an early month rally was reversed on fears about a slowdown in global growth and the US budget dilemma.
- The Canadian bond market was benefitted from growth fears as bond yields fell and drove prices higher. The DEX index gained 2.05% in July. Longer-term bonds were the clear leaders though as 30-year bond yields fell by over 25 basis points to 3.28% and prices rallied by 3.8%.
- Commodity prices were generally stronger last month as the US dollar fell and pushed Gold (up 8.5%) and Silver (up 15.0%) higher. Copper prices also rose while Uranium, Lumber and Natural Gas prices all fell around 5%.
- The Economic data was slow again in July as the 2nd quarter weakness continued in the U.S., Europe and China. Japan was the only major economy to turn higher but still remains 5% below the ‘pre-earthquake’ level.
- In terms of stock sectors, the Basic Materials sector was the only winner, gaining 1.6% on a 3.0% gain for the Gold sub-sector. All the other 9 sectors lost ground in July, lead lower by the Financials which fell by over 6.0%.
- Our Stock Market Outlook is now more bullish than it has been since the lows seen last August. We expect economic growth to recover in the 2nd half and have seen some strong lead indicators of this (auto production, rail car loadings and electricity output all up sharply in July while unemployment claims have fallen). Meanwhile, corporate profits continue to improve with 2nd quarter numbers showing nearly 20% annual gains. Interest rates remain exceptionally low and stock valuations have fallen back to historically attractive levels. We expect stock prices to move higher and could see them surpass their prior highs within the next 12 months.
Financial Markets: Monthly Review and Outlook
Stocks started off July with a rally following the weakness in June, but then gave up those gains and slid back into negative territory as the debate in the US over the debt limit over-shadowed the good news that has come from corporations, which are showing exceptional profit growth once again. Stocks suffered their worst week in the past year during the last week of July which drove the market lower by 2.67% in July and kept it in negative territory for the year-to-date period. U.S. markets suffered similar losses last month as did most foreign markets. In terms of the moves in industry groups in the Canadian stock market, 9 out of the 10 sectors of the TSX fell in July. The only net gainer was the Basic Materials sector, which moved up by 1.6%, driven largely by the 3.0% gain in the Gold sub-index, which was supported by an 8.5% gain in Gold prices and a 15.0% pick-up in Silver prices. Among the weaker sectors were the Financials and Industrials, each of which fell by over 5% on the month. While stocks fell last month, the worries about global economic growth pushed bond yields lower and lead to a 2.05% monthly gain in the core Canadian bond index last month. Longer-term bonds were the clear leaders though as 30-year bond yields fell by over 25 basis points to 3.28% and prices rallied by 3.8%.
While the headline news has been all about the August 2nd deadline for extending the U.S. government’s borrowing limits, the stellar earnings results have gone mostly unnoticed. Second quarter earnings have continued the positive momentum of the past two years as growth once again came in above expectations with a growth rate of 19% year-over-year gains. With over half the S&P500 companies reported, 78% have beaten the consensus earnings expectations, putting the full index earnings at a US$97 level. This means that the S&P500 index, at around 1300, is trading at only 13 times current earnings and these earnings are still growing at close to 20%! The bottom line is that stocks are very under-valued on an historical basis, obviously ignoring all the debate about sovereign debt issues in the US and Europe. In the end, stock markets are all about the valuation of those stocks, the growth rate of earnings and the level of interest rates. All of those factors support a much higher level of stocks overall, but investors are having a hard time seeing this given that all the headlines are about possible U.S. debt defaults as well as bailouts of some of the southern European economies.
However we continue to expect improvements in economic growth in the 2nd half of 2011 and are already starting to see some good early indications of this growth. China’s slowdown appears to have moderated with growth remaining above planned levels and inflation starting to moderate while Japan is recovering from the earthquake-related slowdown in the second quarter. Some investors are worried about other emerging market economies, with Russia and Brazil at the top of the list, but these have been tied more closely to the slowdown seen in Asia. In North America we have seen some recent strength in auto production, rail car loadings and electricity output while unemployment claims have fallen. Private factory and commercial construction spending have also posted robust gains in the lasts two months which suggests that economy activity is set to expand more quickly.
We try to put the attractiveness of the valuation of global stocks in a better perspective in the chart below, which shows the price-to-earnings (PE) ratio of global stocks over the past 25 years. While the average ratio has been 16.4 times over that period, the current level of 11.6 is basically the lowest point we’ve seen outside of the few months on either side of the market lows back in 2009. The argument can also be made that PE ratios should be higher when interest rates are low. With interest rates remaining near all-time lows and little expectation for significant increases in rates anytime soon, it’s easy to understand why we are bullish on the stock market.
