Market Insights: U.S. Households in Strong Financial Position

Macroeconomic and Market Developments:

• North American markets were very volatile, but mostly positive this week. In Canada, the S&P/TSX Composite Index was up 0.47%. In the U.S., the Dow Jones Industrial Average increased 0.82% and the S&P 500 Index was down slightly at -0.06%.
• The Canadian dollar advanced this week, closing at 78.72 cents vs 78.42 cents last Friday.
• Oil prices were up this week. U.S. West Texas crude closed at $91.98 vs $91.07 USD last Friday, and the Western Canadian Select price closed at $79.58 vs $77.36 last Friday.
• The price of gold was down slightly this week, closing at $1,888 vs $1,898 USD last Friday.
• The big focus this week in the markets was the invasion of Ukraine by Russia. There had been a lot of speculation and volatility leading up to the event, but the news itself led to huge bouts of volatility. The U.S. NASDAQ market had already been in correction mode (over a 10% drop from its peak), but this week the S&P 500 Index also officially moved into correction territory on Wednesday, closing down 11.69% from its all-time closing high on January 3, 2022. By the week’s end, the S&P 500 recovered somewhat and is now down 8.35% from its all-time high.
• Home Depot (HD) beat earnings estimates with earnings of $3.21/share vs $3.18/share expected on quarterly revenue of $35.72 billion vs $34.87 billion expected. The company continues to add to a surge in its growth during the Covid-19 pandemic that has lifted the company to its first full year of sales above $150 billion.
• Canadian bank earnings releases started this week, beginning with Royal Bank (RY) on Thursday. Royal Bank (RY) reported better than expected quarterly earnings of $2.84/share vs $2.73/share expected. On Friday, CIBC (CM) reported better than expected earnings of $4.08/share vs $3.67/share expected and also beat revenue expectations with $5.50 billion vs $5.24 billion expected. The company has also approved a two-for-one stock split. This stock was up 5.6% today. Also on Friday, National Bank (NA) reported better than expected earnings of $2.65/share vs $2.23/share on revenue of $2.53 billion vs $2.30 billion expected. The company also announced that Marie Chantal Gingras will be taking over as CFO and EVP Finance replacing Ghislain Parent effective April 1, 2022.
• Ovintiv (OVV), formerly known as Encana, reported quarterly operating income of $331 million vs $183 million a year ago, with production of 508 Mboe/d, slightly lower than the 514.6 Mboe/d expected. The company announced that it is increasing its quarterly dividend by 42.9% to $0.20/share from $0.14/share and provided forward guidance which includes capital investment of approximately $1.5 billion in 2022.
• U.S. Real (after inflation) GDP growth in Q4 2021 was revised up to a 7.0% annual rate from a prior estimate of 6.9%. Nominal (before adjusting for inflation) GDP growth was revised up to a 14.6% annualized rate from a prior estimate of 14.3%. The largest positive contributions to the real GDP growth rate in Q4 were inventories and consumer spending, with the weakest component being government purchases. There were also slight upward revisions to business investment, home building, and government purchases, which more than offset downward revisions to consumer spending and net exports.
• Here is a link to a short video from Canaccord’s chief U.S. Strategist Tony Dwyer entitled Still Ripe for Tumultuous Bounce: DWYER VLOG

Weekly Diversion:

Check out this video of the 5 Stages of Costco.

Charts of the Week:

There is certainly no shortage of both bullish and bearish aspects to the market at present. On the positive side, equity markets (which are a leading indicator) had already mostly telegraphed the news of the Russian invasion of Ukraine, with markets actually bouncing a bit higher in the near-term, with responding sanctions not as harsh as expected and with hope the conflict can be resolved. However, as we have noted, geopolitical events have historically had less of an impact on markets longer-term, than key metrics such as economic growth and inflation which we believe is what is the primary reason behind the current correction. Another bullish point is that markets are oversold, and recently to an extreme level historically, and sentiment readings have been sending strong contrarian buy signals. In addition, Covid cases are down 90% from pandemic peak, high frequency indicators are picking back up and companies in epicenter industries are pointing to a more recent demand recovery. The economic surprise index is also moving higher, consumer balance sheets are very strong with ~2.5T in excess savings and wage gains from a tight labor market. Lastly, Corporate America continues to highlight a solid demand backdrop and pricing power, while 2022 earnings forecasts have recently moved ~1% higher.

Although we’ve seen a global equity correction north of 10%, fundamentals remain solid with strong job markets, growing wages and growing demand. Importantly, U.S. households are in a solid position to spend and invest as shown in the following two charts. Net worth has risen $34 trillion since the pandemic, and they are holding $3.7 trillion cash. This is not a trivial amount and a significant support system to forward-looking growth.

Source: Scotiabank, Federal Reserve Economic Data

On the bearish side of the equation, U.S. Fed interest rate hikes are coming and could be aggressively front-loaded. The current geopolitical issues could potentially slow this pace which may act as a positive surprise later this year. Fed officials are highlighting the need to tighten financial conditions to stem 40 year-high annualized inflation, and G4 central bank balance sheets are certainly headed for a very large decline. There is concern that the Fed tightening will be too much for markets and an increasingly Financialized economy, triggering a growth shock. It is worth noting though that this growth deceleration is from a very high level. However, one may argue a good portion of that growth shock is priced in markets. In addition, geopolitical tensions cannot be ignored this time given the circumstances, and there is some worry that these tensions could only further exacerbate inflation pressures and trigger demand destruction. Lastly, corporate earnings revisions have slowed, and wages are seen as the next pressure point for margins, with some cracks showing at the low-end consumer level with the combination of dampened stimulus and persistent inflation pressures.

On balance, notwithstanding the current geopolitical uncertainties and short-term inflation pressures, the secular bull market remains intact, with strong fundamentals on the growth and credit side of the equation, with our base case scenario being we are in a mid-cycle transition. The first half of this year will likely continue to exhibit above average volatility with the points noted above, but the second half could prove to be strong for markets as the deceleration of growth eases and potentially shifts back to acceleration.

To end this week’s charts, on Thursday the S&P 500 gapped down over 2% prior to the market opening after already being in deeply oversold territory. This is a relatively rare event with 27 prior occurrences since 1993. While not every prior sharp gap lower from an already deeply oversold level has occurred at ‘the lows’, similar price action has led to outperformance with an intermediate to longer-term perspective. As the chart below illustrates, after these instances in the past, the average forward-looking returns have been extremely strong, over three times on average when looking three months out, and approximately double over the next six months and one-year period. That combined with historically extreme negative sentiment that has already factored in much of the bearish aspects noted from the outset, and a 10+% correction behind us (as per the chart yesterday), certainly leads to a strong contrarian viewpoint.

Source: Bespoke Investment Group

Sources: CNBC.com, Globe and Mail, Financial Post, Connected Wealth, BNN Bloomberg, Tony Dwyer, Canaccord Genuity, First Trust, Bespoke Investment Group, Scotiabank, FRED