Weekly Pulse: Market stubs its toe while “kicking the can”

There was a feeling amongst the market that if the U.S. government could broker a “debt deal” that default would be avoided and that investors could breathe a sigh of relief. A deal was finally brokered but the deal did very little to address the U.S. budget deficit longer term. The market responded positively to the deal as most Canadians were enjoying a holiday Monday, but that sentiment soon changed as a terrible ISM Manufacturing print was posted in the U.S. and other global manufacturing prints showed weakness across the board. Couple these prints with the disappointing U.S. GDP print from last week and investors quickly turned into sellers. The U.S. was not the only focus this week as debt problems in Europe emerged again (as most expected they would), but this time discussions were about Spain and Italy instead of Greece and Ireland. The concerns about Europe sent markets into free fall on Thursday even as corporations continued to post reasonable results.

Naturally, resources participated in the downfall as any negative discussion about the U.S., European and global economies puts downward pressure on cyclical commodities. However, the panic of Thursday even forced investors to sell gold as a source of liquidity to meet margin requirements. Oil prices are now in the mid $80 level, which we have not seen since the end of last year.

Currencies were all over the map this week as the Swiss and Japanese central banks purposefully went into the market to weaken their respective currencies and Euro fears pushed investors into the U.S. dollar. The Canadian dollar would fall victim to the U.S. dollar strength and commodity weakness trading around the US$1.02 level when it was at US$1.06 just last week.

In terms of portfolio positioning in this environment, while market values have changed, our recommendations have not. We still believe balanced investors should continue focusing on high quality, blue chip, dividend yielding equities as this market uncertainty persists. For those investors that insist on looking at cyclical stocks, we would advise them to look at larger cap names in this environment as smaller cap equities will likely remain very volatile.

CHART OF THE WEEK: Job Growth…Thank Goodness

 

While we have shown this chart in the past, we can’t overemphasize the importance of U.S. employment to the global economic recovery. After two very disappointing prints and a market plunge on Thursday, investors were expecting the worst on Friday. Thankfully, the actual number of jobs and private jobs created exceeded economist expectations. While we can be pleased with the “beat”, we can’t draw too many conclusions from one month of data, especially since the job prints from the past few months have been so erratic. What we can observe though is that the rate of job creation in the U.S. must accelerate if the recovery has legs to stand on. From Feb 28, 2008 to Feb 28, 2010, the U.S. economy lost 8.75M jobs. Since then, only 1.94M net jobs have been created, meaning 6.8M remain unemployed. Regaining these jobs over the next two years would require monthly net job gains of 283,333…a tall order to say the least!

The Trading Week Ahead
Most investors will agree that we’re happy this past week has come to an end, but is there anything the market can look forward to next week that could turn sentiment around? The one event that certainly stands out is the FOMC meeting and rate decision on Tuesday. While nobody expects any change to the U.S. overnight lending rate, all eyes will squarely be on the Committee’s statement and on Mr. Bernanke in particular to see how they will address the recent slate of disappointing data, even though the employment report exceeded expectations. There may be some “chatter’ amongst investors before the meeting about another round of quantitative easing, but any further stimulus from the Fed must not focus on money supply, but instead on the velocity of money which is simply not changing hands enough to generate growth. The challenge for the Fed is to somehow get money into the hands of the people that need it and will use it as opposed to the banks which will likely hoard it.

Other than the Fed meeting, investors will have a relatively light week of economic data, although the market will certainly be interested in seeing the prints for retail sales and consumer confidence on Friday.

While the earnings train in the U.S. is starting to slow as many companies there have already reported their Q2 earnings, momentum will continue in Canada as we will see earnings reports out of vast cross section of companies and industries.

Commodity prices will likely go the way of the market as long as investors continue to remain focused on macroeconomic and debt problems as opposed to corporate earnings. The Fed meeting will also be important if any new plans are announced that would affect the U.S. dollar. But for now, sentiment remains negative and will likely remain so unless we see some positive economic news in the near future.

Currencies could continue their wild ride next week if the Federal Reserve or the European Union have any surprise announcements in store for us. The Canadian dollar will likely hover north of par if investors continue to move towards the U.S. dollar and commodity performance remains subdued.

Question of the week
U.S. Politicians came up with a “debt deal” this week which nobody seemed to like. Can we relax now that default was averted?

The answer to this question for the next couple of months is yes, but longer term the debt deal did very little to tackle the problem that the U.S. faces which is that it spends more than it collects. One word in particular you would have heard over the past couple of weeks is “entitlements” which are social programs the Government provides for its citizens such as health care and social security. Not only will you hear this word more and more in the future, entitlements are precisely the reason why the U.S. has a spending problem. Below we provide a breakdown of U.S. government spending and tax receipts for fiscal 2010. As you can see, almost half of U.S. spending goes towards entitlements as the population ages, that percentage is only going to increase. So unfortunately the U.S. is still in a terrible spot when it comes to managing its finances, but last weekend’s deal is structured in a way that U.S. politicians won’t have to seriously tackle the issue until after the next Presidential election in 2012.