Looking for signs of good mojo

Be ready when opportunities knock

Looking at today’s economic prognostications and equity markets, an investor might be hard-pressed to find much of what economist John Maynard Keynes called “animal spirits” the innate optimism and “spontaneous urge to action rather than inaction” that drives positive human behaviour. With fears of a global recession mounting, concerns over a slowdown in the U.S. economic engine, uncertainty over monetary policy, and oil prices stuck in the basement despite last week’s mini-rally, it looks like the spirits are unwilling.

But here’s the thing about sentiment: It works both ways. If it’s biased to the upside in good times, it can also overcompensate to the downside in seemingly bad times.

Is that what’s going on now? Bank of Canada Governor Stephen Poloz, speaking to reporters at an international banking conference in Lima last weekend, seemed to suggest that doom-and-gloomers were not paying enough attention to “upside risks” — for instance, the U.S. economy taking off — and actually opined that the “global picture” remains encouraging.

That might be going a little far, but Poloz has a point.

True, the International Monetary Fund recently downgraded its forecast for global economic growth in 2015 to an anemic 3.1 per cent. It also revised down its growth projections for Canada to just one per cent which, until we find out the numbers for August GDP growth, might well turn out to be generous.

Meanwhile, a disappointing jobs number from the U.S. this month lent support to speculation that the Federal Reserve would hold off on an interest rate hike this year which, in a roundabout way, has been taken by markets as a sign that the U.S. economy is stumbling. Yield spreads for corporate bonds have been widening, amid investor concern about falling company earnings.

The greenback, not surprisingly, has been falling, too, down Monday to its lowest point since mid-September, when the Fed surprised markets by holding off on rates. (Gold and oil, meanwhile, enjoyed a bit of a corresponding resurgence last week.)

Trouble in emerging markets, which have been borrowing heavily on low interest rates for the past decade, and the Fed’s positioning are tightly intertwined in this potpourri of worry. And let’s face it: the worries are real and founded. But that doesn’t mean they aren’t overdone, or that there aren’t opportunities for investors.

For one thing, the fundamentals in the U.S. continue to look relatively strong. Consumer spending, which represents about two-thirds of the American economy, grew by nearly four per cent last quarter; business investment grew by more than five per cent; residential construction grew by almost 10 per cent. That’s good for the U.S., and good for Canada. So why so glum?

Meanwhile, Federal Reserve vicechair Stanley Fischer said on the weekend that the U.S. central bank is still poised to raise interest rates this year. The markets have largely ignored those comments, driving down the greenback — such is the state of uncertainty around Fed statements these days — but maybe they shouldn’t.

As for emerging markets, Poloz in Lima rightly pointed out that the IMF revision to global growth estimates was just 20 basis points, and that many emerging economies have worked hard at insulating themselves against U.S. interest-rate moves (by boosting foreign reserves, for instance).

Meanwhile, some emerging market finance officials in Lima actually called on the Fed to raise rates sooner rather than later and let them deal with the fallout. For them, the uncertainty is worse than the reality.

So what if the bad mojo out there is wrong — or, if not wrong, then going too far?

Well, the Fed will have to decide whether it looks like the American economy would be in desperate peril if it raised its target rate by 25 basis points. But if it does what it says it wants to do, we can expect a recovery in the greenback and, perhaps, a switch in sentiment to the upside on U.S. stocks, which have still not recuperated from their August meltdown. In that case, U.S. equity exposure could make a lot of sense.

In fixed income, investors may be over-concerned about earnings and the potential impact of an interestrate hike on corporate bonds. Yields are up, and prices have fallen. So pay close attention to the earnings season we just entered. With the U.S. consumer going strong, consumer discretionary companies (including autos and retail) are expected to post healthy revenues, for instance.

The point is, things are never all bad or all good. They just feel that way sometimes. As market sentiment wavers, a smart investor will be looking for opportunities.