Market activity in 2012 has been very positive compared to the declines we saw going into the end of 2011, and the upward trend continued this past week thanks mostly to a U.S. Federal Reserve (Fed) that put interest rate increases further off into the future. Last year the Fed introduced an interest rate forecast and noted that rates were unlikely to increase in the United States until mid-2013 at the very earliest. However, last week the Fed updated their forecast noting that short-term interest rates should stay close to zero “at least through late 2014” as it tries to help that country’s path to recovery. Such a forecast suggests that interest rates in the U.S. aren’t going anywhere for another two and a half years!
Currency traders sold the U.S. dollar on the news, while equity and commodity investors bought into the market with an expectation that money for corporations and consumers should stay cheaper for longer. Precious metal prices in particular had a strong week as a result.
Admittedly, there is the flip side to this news since the forecast also suggests the U.S. economy is struggling relative to where it should be following the recession of 2008. However, on Friday we discovered that the U.S. economy grew by 2.8% in the last quarter of 2011. While this number was below the 3.0% expected, it does offer investors a glimmer of hope that perhaps the U.S. economy is finally growing on a sustainable basis, albeit at a snail’s pace.
Another driver of the market this week was quarterly earnings, as corporate juggernauts such as Caterpillar and Johnson & Johnson beat expectations. However, Apple was by far the week’s biggest winner after annihilating analyst expectations and building up a cash balance which now stands close to US$100 billion! For a corporation, that is an exceptional amount of money.
How do you like them Apples?
We can’t help but recognize the remarkable quarterly results that were reported by Apple last Tuesday. Simply put, Apple crushed expectations with earnings of $13.87 per share while consensus estimates were expecting $10.06. Our U.S. research partners, Credit Suisse, noted that revenues exceeded their expectations by some $5.5 billion, handily beating even the most optimistic whisper expectations on every metric. The company saw iPhone volumes more than double sequentially while iPad shipments increased 39% quarter-over-quarter. Gross margins reached an all time high of 44.7% while operating cash flow was an astounding $17.5 billion, pushing the company’s current cash level to $97.6 billion.
Trading week ahead
As we look forward to next week, there are four events or themes that should dictate market direction. First, corporate earnings should influence trade flow at the beginning of the week on both sides of the border as Dow components such as Exxon Mobil, Pfizer and Merck will deliver their quarterly results. Second, the lunar holiday will come to a conclusion, so we will see Chinese markets reopen and a Chinese PMI Manufacturing print which is forecast to fall below 50. Third, we will see a continuation and hopefully a conclusion to the ongoing efforts to renegotiate Greek debt prior to that country’s next bailout payment and the expiry of a large sum of debt in March.
And finally, U.S. economic data will be at the forefront mid week as we’ll see key manufacturing and employment data. The ISM Manufacturing Index will be looking for a third consecutive monthly increase on Wednesday, the same day the ADP Employment report will be published, which should show that private jobs are still being created in the U.S. but not as high as last month’s impressive 325,000 print. The ADP report is always a warm up for the non-farm payroll report on Friday where economists are expecting the creation of 150,000 jobs and an unchanged unemployment rate at 8.5%. In Canada, economists are forecasting the creation of 22,300 jobs in the month of January, which would be an increase from last month’s 17,500. However, economists will be paying attention to the details of this report as part time jobs have been replacing full time jobs in recent months.
Commodity prices will likely continue to focus on the movement of the U.S. dollar and as long as we don’t get any unpleasant surprises from Europe, it’s possible the U.S. dollar could see continued selling pressure in the near term.
Question of the week: The Canadian dollar briefly passed through parity this week for the first time since the beginning of November. Why have we seen strength in the Canadian dollar since the beginning of the year?
To answer this question, we actually need to explain why the Canadian dollar weakened in November of 2011. The decline of the loonie was less a result of Canadian dollar weakness than it was European debt crisis at that time created a sense of panic which drove investors into U.S. Treasuries, resulting in the purchase of U.S. dollars and the selling of many other currencies including the loonie.
The sentiment during the month of January has changed somewhat as troubled Euro countries have managed to refinance debt thus far and macroeconomic data out of the U.S. has been encouraging relative to expectations. Therefore the rush to U.S. Treasuries and the U.S. dollar has weakened. However, what really put the loonie through parity this week was the U.S. Federal Reserve’s announcement that it is now unlikely to raise interest rates until 2014 instead of the mid 2013 forecast that was provided last year.
When interest rates increase in the U.S., the dollar becomes more attractive due to the returns that can be generated in that country. However, if rates either decline or look like they won’t go up for a very long time, the U.S. dollar becomes less attractive relative to other currencies. This is precisely what has driven the U.S. dollar lower in recent days, which has only been good for the Canadian dollar and other currencies.
Compounding the strength for the loonie is the fact that when the U.S. dollar weakens, commodity prices such as oil and gold tend to move higher since most commodities are denominated in U.S. dollars. Such moves only reinforce Canadian dollar strength. So, as long as European debt concerns don’t cause yet another panic into U.S. Treasuries, we would expect the Canadian dollar to trade close to parity, if not pass through it, in the near term.