First Quarter 2017- Quarterly Commentary

 

Does anything or anyone, trump Trump?

It was a whirl-wind first quarter – especially after January 20th. A veritable flurry of Executive Orders poured out of Donald Trump’s Oval Office covering everything from immigration restrictions to partial repeal of the so-called Affordable Health Care Act, a.k.a Obamacare. An investigation was started into the new President’s relationship with Russia prior to, during and since the election campaign. The current President says his predecessor had his phones in the Trump Tower in Manhattan “wire tapped”. Stay tuned for more installments of our popular new Washington Week soap opera: “As the Stomach Turns”.

To our report headline “Does anything or, anyone trump Trump?” we think it worth making a few cursory observations. Clearly, the stock market likes him or, if not him, at least his professed policies; for since his electoral victory on November 8th of last year, the value of the U.S. equity market is up over 3 trillion dollars, something the new President is not shy about reminding us. A number of name-brand companies have decided that they should be very public about either not moving jobs out of the country, or very publicly announcing new jobs being created in America. We do not look for the “rust belt” to shake off its particles anytime soon, but it seems a safe bet that companies will think twice before announcing any plant closures with “American” jobs heading for “offshore” destinations.

One of the key realities is that the U.S. economy is not technically lacking for jobs, with a posted unemployment rate of only 4.7%. The real question is: which jobs? While Silicon Valley is screaming for more recruits and Wall Street is back up to full strength, those famous “fly-over” states are still hurting which could explain why and how they voted as they did. Distributing jobs (and wealth) back into these states is what the Trump administration will be trying to do. Indeed, they may not be the same jobs as were lost in the first place, as will become abundantly clear through a look at the coal industry which scored a massive win as Trump, amidst much fanfare, repealed a number of statutes that protected the environment, in an effort to aid coal miners.

Unfortunately, there will not be many coal miners going back to work as most of their jobs will be replaced by robots and coal was already a declining industry. The challenge lies in that many of the unemployed in this industry, like many others, are facing ‘structural’ unemployment, where their jobs have been replaced by automation or other forms of redundancy, not ‘cyclical’ unemployment, which is corrected by a stronger economy and the associated increase in demand.

U.S. Unemployment Rate

Is oil rolling over?

During the quarter, West Texas Intermediate (the benchmark for U.S. crude oil prices) hit a recent high of $55.50 per barrel. This was predicated on:

Oil having over-reached on the downside during the oil price crash in early 2016,

OPEC making its customary noises about “restricting output” and

Russia going along with such a plan.

 

From the get-go, there were those who didn’t believe that OPEC, many of whose members are in serious financial shape (think here of Venezuela and Nigeria, not to mention Russia itself), could sustain production cutbacks for long. Add to that, those who saw that U.S. oil fracking abilities had improved, allowing U.S. production to increase at much lower price levels than previously imagined due to rapidly improving technology. Inevitably, between “news” that OPEC might be producing more oil than it said it would (cartel members cheating? – never!), U.S. production rising again and a milder winter causing a build-up of U.S. crude inventories, oil began to slide from its highs of earlier in the quarter towards the mid forty-dollar range, ending the quarter back at $50, not far from where it began.

Historically, declining energy prices take the pressure off rising inflation and therefore reduce the need for higher interest rates. However, with the U.S. facing full employment and a deep desire by the Federal Reserve to get interest rates to a more normalized level, the bias remains for U.S. rates to move higher over the next year.

What does that mean for the Canadian dollar which tends to be influenced both by oil prices and the spread in interest rates with our southern neighbour? Without a spike in energy prices, and with the interest rate spread widening, the Canadian dollar is likely to trade neutral to slightly lower.

 

Tensions Rising

Moving back to our discussion on geo-political tensions, we came across an interesting item in the news recently. Quietly, and without much fanfare, Sweden (yes, Sweden of all places) has passed a law RE-INTRODUCING THE DRAFT. We had to read that twice too! Sweden has long been famed for its neutrality – through both World Wars – and for being well armed despite this neutrality. One can imagine the hue and cry if Donald Trump were to re-instate the draft in the U.S., yet Sweden has just done so – why? The Swedes appear to be getting both tired of and testy about, Russian submarines hanging around their Baltic coast-line. Add to this that Poland recently welcomed U.S. missiles onto its soil as a deterrent to Russian adventurism in Crimea and Ukraine. Apparently, Russia is not amused by this forward shift of NATO sabres so far towards NATO’s eastern flank and Russia’s “near abroad”. Sabre rattling? You betcha!

Meanwhile on the other side of the world, down in the South China Sea, apparently one just builds islands to lay claim to new territory and then tells other countries in the region to bugger-off. Further to the north, North Korea fires more (and more) missiles into the Sea of Japan which, strangely enough, annoys the Japanese who are now doing everything they can to extricate themselves from the constraints of their post-war constitution preventing the use of the “Self-Defence Force” for purposes other than peace-keeping. China, for its part, remains ticked with its errant province we know as Taiwan due to uneven recognition of the “One-China Policy” Beijing insists upon being acknowledged by all. And at the end of the day, closer to home, no one wants to be Mexico these days as it deals with the new administration in Washington. As ever, the world remains an interesting place in which to live and we haven’t even mentioned the forthcoming French and German elections, a “hard” Brexit or, new-to-the lexicon, “Scexit”, which is Scotland leaving the UK before the UK leaves the EU! Yes, ladies and gentlemen, keep your dictionary of acronyms both handy and up-to-date!

 

You’ve come a long way baby…

We do not mean that in the context for which the phrase became famous in the 1960s and ‘70s, which was the recognition of the progress women had made in the workforce and society of the day. Rather, we thought we should take a moment to revisit where (and, yes, how far) we have come in terms of the equity markets since this extraordinary bull market began. We’ll keep this straight forward for one and all because we only want to put this into perspective: Since the “Great Recession” lows of 2009, the Standard & Poor’s 500 index has risen relentlessly from a low of 666 to recent high of 2400, a gain of a mere 360% in under eight years. In a different context, the S&P500 Price/Earnings ratio bottomed at a level below 14, and now trades at a 25 times ratio. Impressive to say the least! All the more so because during this period we have only experienced two pull-backs in excess of 10%. Since the trough of the last pull-back in January of 2016 the S&P has travelled from 1852 to the aforementioned high of 2400 (+30%).  This rally has been supported not only from growth in the economy, but also by artificially low interest rates.

 

S&P 500 Price Chart

All good news to be sure but it leads to two important questions: Has the market discounted all the good news out there, leaving us vulnerable to a correction near term, and two, will rising interest rates stall the bull market? There’s an old market expression which goes: “Buy the rumour, sell the news”. We’ve had lots of (positive news) rumours about tax cuts, military spending ramp-ups, trillion-dollar infrastructure spending plans, reformed Obamacare plans replete with $337 billion in budgetary savings and other grandiose schemes and pronouncements. When it comes down to spelling out just how this is all to be done, pay close attention to the legislative and budget process, for the details (and the devil) will be in the numbers, as President Trump discovered to his dismay with his initial failure to repeal Obamacare. It must then do two things to become reality: 1) All add up in a way that makes some sense and 2) get passed by Congress. To date, the market has “bought” the rumours…will it soon “sell” the news???