Three factors that might give investors hope amid anxieties about a looming recession
Compelling valuations provide Martin Pelletier reasons to take a contrarian position.
While market participants appear quite worried about the outlook this year, our contrarian nature leaves us leaning toward a positive forecast especially after factoring in some very compelling valuations both in Canada and abroad.
Of note, we see three key factors worth keeping a close eye on which we think could have a meaningful impact on investors’ portfolios.
1)
Central bankers no longer behaving badly
Central banks, especially our own Bank of Canada, have been overly aggressive in our opinion regarding their hawkish views on the economy and interest rates. At first glance, that approach makes some sense given how low unemployment levels are, but a different story is being told by the lack of inflation and the recent removal of liquidity that came with the rapid inversion of some yield curves.
As a result, we quickly went from a strong economic outlook to one that became concerned about the risks of a recession. Overall, we believe these developments will put restrictive monetary policy on hold, which is great news for the markets, as evidenced by their reaction to the recent Fed update.
For example, the Canadian five-year bond yield compressed by just over 20 per cent from near 2.5 per cent down to just under two per cent. In the U.S., 10-years fell from 3.2 per cent to as low as 2.55 per cent before rebounding slightly to 2.7 per cent. There has also been a nice rebound in equity markets, with the S&P 500 posting its best start to the year in more than 13 years. 2)
Oil prices can tell you a lot What a year it was for oil prices with the commodity posting its worst October since 2015 and closing down 26.5 per cent for 2018. It was carnage here in Canada with the differential blowing out thanks to zero pipeline capacity being available resulting in oil-on-oil competition. Luckily, the Alberta provincial government stepped in and forced those extra barrels off the market providing a temporary solution.
That said, the drama resulted in a mass sell-off in Canadian oil stocks, which make up about 20 per cent of the S&P/TSX. As a result, the index is now trading at its lowest P/E multiple in six years and the biggest discount to the S&P 500 since 2002.
The good news is that oil prices are rebounding to start the year, which is a positive sign for what lies ahead. Specifically, WTI crude oil is now back above $50 a barrel and up more than 20 per cent from its December lows on U.S.-China trade talks and Saudi output cuts.
Oil’s rebound is important because oil prices are a great leading indicator of the health of the global economy. A strong environment for crude oil will therefore put concerns about a recession to rest.
3)
Trade wars and currencies
The Canadian dollar took a beating last year giving back the gains it made in 2017. Overall, we calculate that it lost 7.5 per cent against the U.S. dollar last year. Consequently, this provided some downside protection for those holding U.S. priced assets including stocks. For example, U.S. equities lost nearly four per cent on an own-currency basis, but ended up in slightly positive territory when adjusting back to Canadian dollars.
We see no reason why the Canadian dollar won’t continue to be range bound as it has over the past two years, with moves to the upside and downside dependent on the state of the oil market.
That said, we still have a madein-Canada energy crisis with a federal government pushing ahead with a punitive and restrictive Bill C-69, which could exacerbate the problem. As a result, any upside from global oil prices may not be reflected in the currency as much as has been in the past.
Finally, we would expect some clarification on the ongoing China-U.S. trade dispute this year that could be beneficial to Canada, which has been caught in the middle of a very difficult situation.