Market Insights: Third Quarter wrap-up

Global equity markets endured their worst quarter in four years as investors worried about a China-led global slowdown and a possible rise in short-term interest rates in the U.S.  We are not as concerned about the latter as the tightening cycle should indicate that the U.S. Federal Reserve is less worried about the impact of the slowing global economy.  Also, if history is any indication, the time to the next U.S. recession should still be at least a couple years away. The below chart illustrates the duration of past rate hike cycles and as well as the time to next recession.  As you can see, the average and median amount of months until recession once the tightening cycle begins is 41 and 33 months respectively.  At present, the futures market isn't predicting the first rate hike until early next year.  In our last quarterly update, we made this forecast when the futures market was pointing to the first rate hike in September which did not happen.  

 

                                                          Source: Deutsche Bank

 

How the Chinese economy performs as it transitions from an investment-based economy to a consumer-driven economy, on the other hand, will have a broader impact in our view and is not to be ignored.  Perhaps this will have an even greater impact, and likely already has, on the Canadian economy with respect to China’s very large demand for commodities.  

The Canadian economy contracted for two straight quarters but it is widely expected that the third quarter will be positive.  It remains to be seen if the upcoming election results will rattle business sentiment, but even if it does we believe the recession will be short in duration and magnitude.

Based on the following fundamentally-driven positive factors (we discussed here) still in place for the world's largest economy, we continue to believe we are in a long-term bull market in the United States and that we have witnessed a short-term correction (some may say overdue) in the markets.  In addition to those factors, we have recently seen a new cycle high in consumer confidence, generational lows in initial unemployment claims, historically low household debt service ratios and delinquency rates and improved housing trends.   

These corrections can be normal as a re-pricing of equity risk premium.  If we can see the technical picture clear up with markets pushing above overhead resistance, we will look for opportunities to increase equity exposure.  On the other hand, we continue to monitor our own long-term equity action call indicator which remains neutral and will make adjustments accordingly if we see this shift into an unfavorable position. 

We are hopeful that the energy, materials and industrials sectors that led from the last major correction (2011) will also lead from this one.  This should bode well for the resource heavy Canadian equity market if we see a similar story this time.    

 

Here is our Milestone Market Report on economic data, capital markets, commodities and currencies through September 30th: