Market Insights: Summer doldrums?

Summer doldrums?

We must preface this by noting that this performance generalization about equity markets in the summer months is not overly accurate nor an efficient tool to make long-term investment decisions on. However, for the purpose of this post, the markets have indeed struggled the last few weeks and months.  

The MSCI All-Country World Index (USD) is down approximately 4-5% since the beginning of summer and we have seen periods of heightened volatility.  Closer to home, our TSX Composite is in a rough patch, now down almost 10% from its closing high on April 15th. Energy markets continue to suffer with the price of oil closing in on $40USD.  

Globally, we have seen a mixed economic picture and there is definitely reason for some caution at this point in time (relatively strong U.S. economy and profit growth, slowing global growth, commodity bear market, China currency devaluation, upcoming Fed rate increase), but our focus remains on the long-term trend and we continue to remain positive.

What keeps our stance positive right now?  The actual drivers of the world's largest market (U.S.) and some global markets remain in place and as an extension our own market as well (excluding energy).  

What are these U.S. drivers? (Courtesy of Canaccord Genuity's Portfolio Strategist Tony Dwyer):  

1. "The equity market is most closely correlated to the direction of earnings, which remains positive, even with negative impact from Energy;
2. The direction of earnings is driven by economic activity, which remains in uptrend;
3. Positive economic activity is driven by the steepness of the yield curve and availability of money – both of which remain very stimulative;
4. The steepness of the yield curve and availability of credit is driven by Fed policy, which should be extremely accommodative through the end of 2015;
5. Fed policy is driven by core inflation, which should remain historically low — even on an uptick."

In looking at these drivers more closely, we would note the following points underlying them:

• An accommodative monetary policy as seen through the Real Fed Funds Rate is still present.  This measure could rise a full 1% and still be at the lowest level of the past two cycles.  The same could be said for Europe and Japan whose policies remain accommodative. 
• Low core inflation as represented by the U.S. core personal consumption expenditures (PCE) price index gives flexibility for the Fed to raise rates at a more moderate pace than previous cycles.  Canada is still much further away from any rate increase.
• Valuation expansion: the average U.S. equity market multiple when core inflation is between 1-3% is 19x (which is a fair amount higher than at present) and the current trend is pointing in that direction.
• We have a positive and steep yield curve.  Every recession since 1950 has been preceded by an inverted yield curve, and that scenario at this point seems years away.  Yield curve inversion tends to precede recessions by approximately 15 months.​

Keeping a clear focus on the long-term picture can ease the frustration of short-term weakness and volatility.  Our stance remains positive; however, we remain flexible if these current drivers in place begin to dissolve.