This article is a guest contribution David Andrews, CFA, Director, Investment Management & Research, Richardson GMP Ltd.
And so the debate continues: are we experiencing a price correction in an ongoing bull market or are we in fact witnessing a fundamental change in the business prospects around the world? Heightened market volatility, which has been with us for several weeks now, is likely to continue until conclusive evidence shows the problems plaguing peripheral Europe can be contained and China can successfully orchestrate an attempted economic “soft landing”.
Europe and the Euro (€) have continued to dominate headlines with the currency having fallen 7.5% against the U.S. dollar in the month of May making it the worst performer among 16 major currencies in 2010. China put its influential weight behind the Euro currency last week as it quashed reports their vast European debt holdings were under review. In a show of China’s growing global influence, the Euro currency, most commodities, and global equities all surged when China claimed those reports as “groundless”. Despite the upward surge by equities last Thursday, most stock markets are experiencing their worst month of May performance in quite some time. The Dow Jones Industrial Average suffered its worst month of May since way back in 1940. Can stocks bounce back in June? Prevailing low interest rates, low inflation, and strong corporate profitability do provide a positive fundamental back drop for equities. It also helps that the Asian economy remains strong and the North American is now showing signs of rebuilding its momentum. The caveat to this outlook, in the short term at least, looks to be more political than fundamental in nature.
The previously announced €750 billion bailout package has lost much of its lustre. There is a growing sense the EU/IMF bailout will be insufficient to save Greece from defaulting on its debt obligations. Perhaps more concerning is the potential for the other “fiscally challenged” Eurozone countries to suffer a similar fate. Either way, investors are now trying to gauge the future impact of slower growth, higher taxes, and the knock on effect to the global economy. Both Spain and Italy announced budget cuts and higher taxes as they attempt to get their respective fiscal situations in line with EU prescribed rules of deficits not exceeding 3% of GDP by 2014. It is proving politically difficult to achieve these deficit targets as recent austerity measures and budget cuts were passed by the minority government of Spain by the slimmest of margins (1 single vote). As an aside, Fitch Credit Ratings took a page out of the “Better Late than Never” handbook and downgraded Spain’s credit rating one notch to AA+ last Friday. Adding to the market’s confusion ahead of the U.S. long weekend was the rating agency’s decision to maintain the outlook on Spain as “Stable”... Another wild card for markets last week included North Korea as it rattled its sabre and threatened “all-out war” over accusations by South Korea that the North was responsible for the sinking of a South Korean warship in March.
Crude oil also made headlines last week, mostly for the wrong reasons. The oil leaking into the Gulf of Mexico has surpassed the volume spilled by the 1989 Exxon Valdez accident making this the worst environmental disaster in U.S. history. Efforts are underway to cap the leak but so far success has remained elusive. Public anger over the catastrophe has increasingly targeted the Obama administration for its slow and uncoordinated response to this growing ecological problem. Also last week, NOAA released its forecast for the 2010 Atlantic Hurricane season. It appears this year may rival 2005(Katrina and Rita) for the frequency and intensity of storms. Oil and Natural Gas prices both rose on the prospect of an intense season that kicks off in June. Speaking of kick offs, Memorial Day weekend is the official start of the U.S. driving season where fuel demands begin to rise. Oil has returned to the mid $70s after having broken below $70 last week. Prices will remain volatile until the economic impact of a weaker Europe becomes clear.
As previously mentioned, the North American Economy continues to build momentum as evidenced by better than expected U.S. home sales in April and rising consumer confidence data for May. First quarter U.S. GDP (3.0% annualized growth) showed the world’s largest economy is recovering, albeit at a moderate pace. This week, the market should focus on the May employment report. Also to be released, but unlikely to move the market’s needle, are vehicle sales and some manufacturing data for May. Auto sales are expected to maintain their upward trajectory but more critical is the pace at which jobs are being added. The consensus view on employment is for 500,000 new positions added for the month. This follows April’s data where a surprisingly strong 290,000 new jobs were added. The unemployment rate should move down ever so slightly to 9.8% in the U.S.
In Canada, the big news this week will come on Tuesday when the much anticipated Bank of Canada interest rate policy is announced. The market is expecting the central bank to increase interest rates by at least 0.25%. The Canadian economy will report growth for the first quarter this week as well, making it a third consecutive quarter of stellar growth which should add to the central bank’s case for higher interest rates. We expect this interest rate announcement will be the first of several 0.25% increases over the next number of quarters. Canadian employment data for May will also be announced on Friday and we expect 20,000 new positions were added helping to drop the Canadian unemployment rate to 8.0%.
