Market Insights: Is the Market Getting Frothy?

Macroeconomic and Market Developments:

• Stock markets in North America were positive this week. In Canada, the S&P/TSX Composite index was up 1.25%. In the US, the Dow Jones Industrial Average was up 1.95% and the S&P 500 was up 2.71%.
• The Canadian dollar was up slightly this week, finishing at 79.8 cents vs 79.7 cents last week.
• Oil prices were mixed this week. US West Texas crude oil closed lower at $59.40 vs $61.20 last week and the Western Canadian Select oil price finished flat at ~$49.00, roughly the same as last week.
• Gold prices were up this week, closing at ~$1,743 compared with ~$1,731 last week.
• Last Friday, while the markets were closed for Good Friday, the US released a much stronger than expected March employment report. Nonfarm payrolls surged 916K, well above the 660K consensus. In addition, net upward revisions to prior months totaled 156K. The US Unemployment Rate dropped from 6.2% to 6.0%.
• Air Canada and Transat A.T. Inc. announced that they have mutually agreed to terminate their agreement for the proposed acquisition of Transat by Air Canada. The two companies had originally agreed in June 2019 on the acquisition, the terms of which were subsequently amended in August 2019 and then revised again in October 2020 because of the severe economic impact of the COVID-19 pandemic. Air Canada is paying Transat a termination fee of C$12.5M, and Transat is no longer under any obligation to pay Air Canada any fee should Transat be involved in another acquisition or similar transaction in the future.
• The US ISM Non-Manufacturing (Services) index rose to 63.7 in March, easily beating the consensus expected 59.0 (levels above 50 signal expansion: levels below signal contraction). The 8.4-point jump in the headline index represents the second largest monthly rise in series history, behind just June 2020 when the index was emerging from the shelter-in-place orders that decimated activity. The March reading of 63.7 is the single best reading since recording began back in 1997.
• In the International Monetary Fund’s World Economic Outlook, the agency projects global growth at 6.0% for 2021 and 4.4% in 2022 (upgraded from its respective +5.5% and +4.2% forecasts released in January). They also boosted their 2021 US projection to 6.4% vs prior 5.1% and China to 8.4% growth vs prior 8.1%. For the Canadian economy, its outlook projects 5.0% growth in 2021, 1.4% above its prior projection and the steepest increase among advanced economies.
• On Thursday, Canopy Growth Corporation (WEED) and The Supreme Cannabis Company (FIRE) announced that they have entered into a definitive arrangement under which Canopy will acquire all of Supreme Cannabis' issued and outstanding common shares in a transaction valued at approximately $435M on a fully diluted basis. The transaction provides Supreme Cannabis shareholders with a premium of approximately 66% based on the closing prices of the Supreme Cannabis and Canopy shares on April 7th.
• The US Producer Price Index (PPI), which is one measure of inflation, was released on Friday. After February's energy-driven 0.5% rise in producer prices, March’s numbers showed a monthly increase of 1.0% vs consensus estimates of 0.5%, equating to yearly growth of 4.2% vs consensus estimates of 3.8%. This is yet another indication that inflation is heating up as the economy recovers from the COVID-induced recession.
• This Friday, Canadian jobs numbers for March were released showing our economy gained 303K jobs last month, well above ~85K consensus and beating expectations for the second straight month. Employment is now back within 1.5% of pre-COVID Feb-2020 levels as both full-time (+175,000) and part-time (+128,000) employment increased. The unemployment rate declined by 0.7% to 7.5% from 8.2%, also better than forecasts.
• Total global cases of COVID-19 finished this week at 134.3 million, with the total deaths at 2.91 million. In Canada, total cases now stand at 1,036,023, with active cases at 64,291. In Alberta, total cases are 156,905, with active cases of 12,187.
• For a deeper dive, the US investment company First Trust has put out a US COVID-19 Tracker. Click here: COVID TRACKER

Charts of the Week:

One important measure of how ‘frothy’ a market can be is called the Investors Intelligence Bull vs Bear report. This month the bulls moved up to 60.8% from 54.4%, which is historically quite high. The report noted this was highest since mid-January and approaching peak readings of 64.7% set in late November and 63.7% in early January. Investors who are bearish slipped to 16.7% from 17.5% and are just above the mid-January low after hitting 20.6% in early March. Both the high level of bullish investors and the low level of bearish investors would typically give us pause. It might seem counterintuitive that when more investors are bullish, we would consider that as a warning sign. But, in reality, once everyone has jumped into the market, there are fewer investment dollars to push up stock prices.

That said, this chart shows CNN Business’ Fear & Greed Index. When greed is running high, stocks can go up but in turn become more vulnerable to anything that disrupts the euphoria. As this shows, the market isn’t at a point of being overly exuberant, so this indicates that the market isn’t ‘running too hot’ at the moment.

Source: CNN Business

With Q1 2021 now in the books, it is very interesting to look at what sectors have been performing well lately. Coming out of the COVID-meltdown last year, a lot of tech stocks led the charge. However, since mid-November when Pfizer and Moderna released very effective vaccine results, the market has shifted away from some of those ‘work from home’ stocks to more of the ‘get back to normal’ stocks. As you can see from this chart, the worst performing sectors within the S&P/TSX from last year are outperforming this year, led by Energy (+20%) and Health Care (+37%). On the flipside, Technology is up 2% this year vs 80% last year (driven in large part to Shopify).

Source: S&P Capital IQ

On the positive side, there is likely solid justification for this optimism. We are currently seeing very strong economic data across the board, mostly accelerating. The Bespoke Investment Group publishes their Economic Diffusion Index which measures the pace at which dozens of economic indicators are coming in ahead of (or below) consensus economist estimates over a 50-day period. The markets are a leading indicator in themselves, therefore, when it comes to economic data that feeds into people’s decision to buy, hold, or sell, it is usually more important what happens relative to expectations than the actual result itself. The following chart shows this diffusion index over the last 20+ years. Any number above zero indicates that economic data is surprising to the upside, while negative readings show that data is not living up to expectations. When you pull out the last 12 months (bottom grey section), you can see that the readings have been positive except for just 33 days. That means the diffusion index has been positive on almost 85% of the trading days over that time. This is the highest reading in the last 20 years! It also included the highest individual reading of 42 in early October. One may think this is also a contrarian signal, however, while we won’t get into all the data here, we can say that in past times when this same reading has been at 75% or higher (diffusion index positive on 75% or more of all trading days in the past 12 months), market performance over the following year has been strong. In addition, in two of the three prior periods, it was near the beginning of very long expansionary periods.

Source: Bespoke Investment Group

 

Sources: CNBC.com, Globe and Mail, Financial Post, Government of Canada, Johns Hopkins University, oilprice.com, Canaccord Genuity, Tony Dwyer, CNN Business, S&P Capital IQ, Bespoke Investment Group