October 19, 2018
Making Cents of the Markets
Be In the Know
The week ended on a positive note after some stronger corporate earnings, but October continues to be tough for investors. Month-to-date the S&P 500 is now -5% and the TSX down -4%, while global markets measured by MSCI World ex USA are down over -6%. Technology companies have been particularly hit hard, with the tech-heavy NASDAQ index down over -7% in October. There have been a number of headwinds this month, but we expected some volatility leading up to midterm elections in the US which are in 18 days and counting. Underlying economics in the US however, continue to be strong, and global GDP growth has been revised only slightly lower to 3.7% from 3.9% this year.
We had some companies we own report earnings this week, all of them beating expectations on both revenues and earnings per share, after JP Morgan Chase also beat both on Friday last week. UnitedHealth Group’s revenue came in at $56.56 billion, with earnings-per-share at $3.41, versus expectations of $56.34 billion and $3.29 per share. CSX Rail’s third-quarter net income almost doubled to $894 million, or $1.05 per share, topping the average estimate of $0.94 despite disruptions from Hurricane Florence. On Thursday we had CP rail report record earnings that they had pre-released a couple of weeks ago, with revenues of $1.9 billion and earnings-per-share of $4.12 versus expectations of $1.6 billion and $4.07 per share. A good start to Q3 earnings season for our Legacy positions, at least in terms of fundamentals.
Canadian inflation slowed more than expected in September, down to 2.2% year-over-year after hitting 3% in the summer. The spike in July and August were largely due to a jump in transportation costs, which are more volatile with airfares and gasoline prices rising. The Bank of Canada mentioned at the time it was likely noise, as core inflation was in line with expectations. The Bank of Canada has indicated higher interest rates will be needed to keep inflation on target, and next week we expect them to lift the overnight rate to 1.75% from 1.50%. These expectations have been priced in to the markets and the Canadian dollar for some time now, so the emphasis will be on what they guide going forward. Household debt remains a problem in Canada, and raising interest rates too quickly could slow Canada’s growth.
We have written about this before but as an update, three economic indicators together have successfully predicted the last seven recessions, without a single false-positive. The yield curve inverting, the year-over-year leading economic index contracting (includes factors such as commercial jet purchases, interest rates, manufacturing jobs, etc.), and the tightening of monetary policy. The yield curve is not inverted, the year-over-year leading economic index is growing over 6%, and monetary policy rates are still at very accommodative levels. Tailwinds continue to be strong for equity markets, but headwinds have given us the second pullback of the year. Given that among other things, the US economy regained status as the “World’s Most Competitive Economy” for the first time in a decade, we think this is providing buying opportunities as we look to put our 20%-27% cash levels to work.
Stock markets are expected to have a strong end to the year, once the uncertainty of midterm elections has been lifted. This is regardless of outcome to the balance of political power. A split Congress, with the House going to the Democrats and the Senate going to the Republicans, is what the market expects right now and is likely priced in. A Republican sweep would generally be net positive for stocks, with a Democrat sweep likely being net negative. As mentioned, markets do not like uncertainty so there should be more upside once the elections are over and investors can re-focus on strong fundamentals like earnings, which are currently growing at over 20%. Historically, the year after midterm elections, stock markets are overwhelmingly strong as well. The S&P 500 hasn’t declined in the year after midterm elections since the 1946 cycle – and has climbed 15% on average – regardless of which party won or lost control of Congress.
Chart Of The Week
From Ned Davis research, sourcing The Conference Board in the US: The leading indicators in the US are still growing, despite recent stock weakness. Gray areas are economic recessions:
Beyond the Markets
Marijuana is officially legal in Canada as of October 17th. Following Uruguay, Canada is the second country in the world to fully legalize marijuana for recreational use.
Here are a few facts you might be interested in knowing after legalization:
- All provinces and territories have different rules on where you can buy it. The federally mandated minimum age for consumption is 18, but some provinces have opted to raise it to 19 and in Quebec, 21.
- Selling to minors and driving under the influence are prohibited
- The main goals of legalizing marijuana is to stop money from going to the black market and to make it harder for minors to get their hands on it.
- Only purchases from officially recognized stores will be legal, so buying/selling otherwise could have consequences.
- It is illegal to bring marijuana from Canada into the U.S.
Listen to Part 1 of our Vancouver Real Estate Series on this week’s CKNW of Making Cents of the Markets here. Tune in next Wednesday at 8:40am on CKNW to hear Part 2 to learn the pros and cons of investing in the stock market versus real estate.