Although the global economy appears to be recovering, investors were reminded this week that growth does indeed remain tepid and the recent economic momentum markets have enjoyed can wax just as easily as it can wane. China’s manufacturing sector continued its 5-month slump as evidenced by the flash PMI data for March. At the same time the Eurozone economy is showing signs of weakening once again with both German and French manufacturing posting sharp declines. The Chinese weakness and the troubles in Europe are clearly linked since the Eurozone is China’s biggest export partner. These recent developments leave the United States as the only bloc showing signs of strength at the moment, and traders decided to pare their bets this week sending crude oil and base metal prices lower. Government bond yields, which had been rising in recent weeks, dropped as growth concerns began to re-emerge this week. Traders seem less convinced yields will perpetually move higher from here given the news outside of North America. Growth in the U.S. looks decent, but it remains intertwined with the rest of the world where the outlook is far less certain. Coincidentally, Goldman Sachs released a report this week which suggested investors wave ‘good bye’ to bonds and say ‘good buy’ to stocks. Timing, as they say, is in fact everything.
North American economic data this week focused on the soft spot in the economy, specifically the U.S. housing market. The number of housing starts and the number of existing and new homes sold in February were once again a grand disappointment. Despite improving employment prospects, increasing consumer optimism, and rock bottom mortgage rates, homes are still being sold very slowly, which is an overhang on the economy. Next week’s house price data should also be quite weak. A precursor to a possible real estate stimulus program (QE3) by the Federal Reserve perhaps?
No significant M&A news this week, but corporate headlines included a new dividend for Apple shareholders (the first since 1995). With the new iPad selling well and the stock trading at $600, shareholders seem pleased with these developments. Database software giant Oracle reported strong earnings results in its third quarter which provides more grass roots evidence of the global recovery.
COPPER SUGGESTS RALLY MAY FADE
Copper has historically been one of the best leading indicators of global growth. The orange line on this week’s chart shows the relationship between crude-oil and copper futures and the S&P500 Index. When copper prices accelerate faster than oil (a rising orange line), stocks have tended to do very well. When the price ratio moves in favor of crude, stocks have tended to pull back. Since February 6th, the Copper- Oil ratio has fallen 9%, but the S&P500 has actually increased 4.6%. Stock investors could see stocks pullback unless the price of copper starts to move higher (on positive global growth news) or the price of crude begins to fall from current levels.
ECONOMICS THIS WEEK
| Event | Consensus Estimate |
Prior |
|---|---|---|
| Monday March 26 | ||
 Pending Home Sales MoM (Feb) |
1.0% | 2.0% |
| Dallas Fed Manf. Activity (Mar) |
16.0 | 17.8 |
| Tuesday March 27 | ||
| Case-Shiller 20 City MoM (Jan) |
-0.3% | -0.5% |
| Consumer Confidence (Mar) |
70.0 | 70.8 |
| Richmond Fed Manuf Index (Mar) |
18 | 20 |
| Wednesday March 28 | ||
| Durable Goods Orders (Feb) |
2.9% | -4.0% |
| Durable Goods ex Trans (Feb) |
2.0% | -3.2% |
| Thursday March 29 | ||
 Industrial Product Price MoM (Feb) |
0.5% | 0.3% |
| Canadian Federal Budget |
||
| Q4 GDP QoQ (Annualized) |
3.0% | 3.0% |
| Personal Consumption Q4 |
2.1% | 2.1% |
| Initial Jobless Claims |
350K | 348K |
| Continuing Claims |
3365K | 3352K |
| Friday March 30 | ||
| GDP MoM (Jan) |
0.1% | 0.4% |
| GDP YoY (Jan) |
1.8% | 1.8% |
| Personal Income (Feb) |
0.4% | 0.3% |
| Personal Spending (Feb) |
0.6% | 0.2% |
| Chicago PMI (Mar) |
63.0 | 64.0 |
| UofMichigan Confidence |
74.8 | 74.3 |
TRADING WEEK AHEAD
Last week, we took note that not all lights on the global recovery were flashing green, especially in the manufacturing sector. In the week ahead, we will get an updated read on America’s manufacturing in Texas and Virginia with data outlining what manufacturers there are thinking about their future prospects. Also out are durable goods orders which are expected to show the biggest increase in eleven months, mostly due to rising aircraft orders at Boeing. Consumer confidence data could end up a little mixed as the recently improved labor market may offset the rising cost of gasoline which tends to dampen what kind of mood consumers are in. Late in the week, income and spending data will likely reflect the pick-up in the employment market of late.
The 2012 Canadian Federal Budget will be released after the close on Thursday, and should be the key highlight in Canada. With global economic developments far from certain, Finance Minister Flaherty’s tone has softened recently suggesting the budget will not be austerity driven. Cuts to the public service and changes to Old Age Security, which had been telegraphed by Mr. Flaherty, are likely to be on the dovish side if they happen at all.
SELECTED EARNINGS THIS WEEK
| Company | Date | Consensus Estimate |
|---|---|---|
| Apollo Group Inc. |
Mar 26 | $0.37 |
| Genivar Inc. |
Mar 26 | $0.44 |
| Alliance Grain Traders |
Mar 27 | $0.39 |
| Walgreen Co. |
Mar 27 | $0.77 |
| EXFO Inc. |
Mar 27 | $0.08 |
| AGF Management |
Mar 28 | $0.27 |
| Family Dollar Stores |
Mar 28 | $1.13 |
| The Mosaic Co. |
Mar 28 | $0.68 |
| Sprott Inc. |
Mar 29 | $0.06 |
| Research in Motion |
Mar 29 | $0.82 |
| SNC-Lavalin Group |
Mar 30 | $0.28 |
| Best Buy Co. |
Mar 30 | $2.15 |
QUESTION OF THE WEEK
Exchange Traded Funds have been blamed for exacerbating market volatility, causing high correlations among stocks and influencing returns. Are these claims justified?
Exchange Trades Funds (ETFs) have been blamed for intensifying stock market volatility but there is a lack of statistical evidence to support the claim. From a trading perspective, ETF dollar volumes are still small in comparison to the cash and futures markets for stocks. There is a misconception that every trade in an ETF results in an equivalent trade in the underlying stocks as well. The reality is that the underlying stocks trade only about 15% of the time. More often, ETF trades are hedged using futures, options, or combinations of derivatives rather than the stocks themselves. There is also a strong belief that ETFs affect stocks more at the end of the trading day, especially for leveraged ETFs looking to settle. Again, the ETF rebalancing volumes are very small relative to the overall stock volumes, so the impact is minimal. As well, most ETF trading activity occurs at the beginning of the trading day rather than the end. This may be because ETFs are macro oriented tools and users tend to make moves based on overnight or morning news events.
Since the 2008 financial crisis, stock correlations have increased which is basically another way of saying stocks have tended to huddle together and move in the same direction at the same time. High correlations tend to mitigate the positive effects of good stock picking for active managers since portfolio returns are more dictated by the “risk on/risk off” trade rather than the companies themselves. The rise of ETF use has coincided with rising correlations but the relationship is anecdotal. So far in 2012, correlation amongst stocks has shrunk while ETF use has continued to increase. High stock correlations are more likely associated with the heightened degree of macro-economic uncertainty in the world. As long as the outlook remains clouded and uncertain, ETFs will continue to win favor with traders as the most efficient means of putting on and taking off risk bets.
David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends.
@David_RGMP