All of a Sudden Things Changed for the Loonie?
April was kind of like January but only different. In January, we experienced a significant surge in the value of the US dollar relative to the Canadian dollar. Holding US dollar investments at that time felt pretty good. In April, the Canadian dollar surged while the US dollar languished. The move was about a 5 percent. Holding US dollar investments in April felt difficult as the Canadian dollar surged. There are a few reasons for this short term move, and lots of reasons to believe that this is not a permanent condition.
When we look to the currency strategist and get their view, the world is currently painting a more modest picture for the Canadian dollar. The chart below illustrates the actual historical move in the USD relative to the CAD in the last couple of quarters, and the two lines coming off of the historical movement represent the median assessment of all currency analysts measured (72 at this point that we track) and the high expectation of that same group. It should be interesting to note that the current spot rate is 1.21 (or 0.825) at the time of this writing (May 4, 2015), or about 4 cents below current expert expectation.
Now, we also know that no one person can predict the future with any certain consistency so we look at this as one guide post. If the currency analysts are at all right with their bullish posture on the US dollar, it will continue to remain reasonable to have assets exposed to US dollar denominated assets.
The second place we look is in the pure economic construct of our two economies and their economic forecast. Canada, as we know, has been in sort of a bifurcated economy. Where on one hand we have seen a collapse in the commodity space, namely or more acutely the energy space, yet in certain centers housing continues to roll up in price. Maybe Canada is just that great of a place to live. Cheap gas and expensive homes? Below we have posted a chart of the recent forecast of economists and their outlook, historically speaking, for the Canadian economy. The chart tells most of what we already know and that there has been a degree of weakening in Canadian GDP forecast.
To be fair, we need to compare Canada to the US and the chart below tells a similar story; one of decline in the US GDP forecast.
The interesting component is that the relationship over time is different. Canada will likely follow the US’ lead well into our future, and it is unlikely (unless we have another commodity super cycle) that Canada will lead the US in growth.
Currency will continue to play into the outcomes of many investments over the years, and for now the US dollar remains the reserve currency of the world and we remain comfortable with owning some of it.
What Have we Missed?
When we look around, we can always do it with a strong degree of hindsight, typically 20/20. It also remains important to keep some perspective. We looked at the TSX recently to determine what we might be missing and what risk would be associated with that miss. Interestingly, the TSX Health Care sub group was responsible for 53.42% of the TSX return up to May 4, 2015. If we look at that index, it amounts to 5 stocks. Yes, 5 stocks have or hold responsibility for over 50% of the year to date return of the TSX. If you have held them, you are likely holding a positive return. If not, the market has remained challenged.
We went and looked a bit further out to see what might be really happening, and the results remain somewhat challenged. The chart below shows the TSX simple price return since July of 2014. There is nothing exciting about this chart other than the observation that nothing has really happened. Yet, a lot has. The chart illustrates the degree of volatility or movement the index has had, yet with little actual gain. We are getting into a 10 month washing machine. Someone recently suggested that we are at a Triple Lindy risk level where clearly anything can happen at a moment’s notice.
Where do we go from here?
As always we are faced with the prospects of: will this get better, am I going to survive this, and when will it start to just go up? We often times see these as binary outcomes. Will this get better? Yes, at some point. You get the point. Here are some thoughts we have and some things we think we know. Europe is in the midst of quantitative easing (QE). When the US undertook quantitative easing, the stock market went up. Will Europe go up as the US did? Below is a snapshot of the cumulative increase in European Quantitative Easing in orange, and the in blue. The anticipation of QE is clearly evident. The questions remains whether it is persistent and continues to propel European indexes. Only the future knows the answer, but history has provided lots of hints that the outcome will be a yes.
For the most part, we see positive signs form the market at this point suggesting that the current bull market has some legs remaining. There is a sense of fatigue at this current juncture, but economic indicators remain in a positive camp.
There are both technical reasons for this thinking and fundamental reasons. If we scratch the surface of valuations, we can see that historically the Price Earnings multiple of the S&P 500 is or has gotten stretched. Historically, one could argue that there is still a lot of room left for multiples to expand, and perhaps they will. For now, it remains apparent that valuations continue to expand.
We have often heard that you cannot fight the FED. This basically means that if central banks around the world are prepared to add to or provide stimulus for their economies they will. They can through everything from the kitchen sink to leftovers of the economy to get it moving in the right direction. We know this from 2008 and 2009. The strongest current evidence of this is Canada. The chart below illustrates the movement of the TSX against the overnight rate (stimulus) administered by the Bank of Canada. Some would argue that the Bank of Canada’s recent efforts have had some teeth and helped propel or sustain better equity markets in Canada.
Thank you for taking the time to read about our insights and thank you for your continued support. Enjoy the onset of spring!