Notwithstanding the holiday shortened trading week, a slew of important developments helped push the Euro to a ten-week high versus the U.S. dollar and helped drive commodities, specifically WTI and Brent oil prices higher. As a result, the TSX index jumped 2.1% this week and the Dow Jones Industrial Average revisited the psychological 13,000 point level; a level last seen in May of 2008.

At last, the Greek austerity negotiations and debt swap marathons concluded, but equity and bond markets reacted quite differently to the news. Initially, stocks traded lower on concern that the terms of the bailout deal simply won’t be enough to solve Greece’s growing problems. The deal contains puzzling assumptions on growth and investors remain suspicious of the follow through on the austerity measures, especially with elections being held as early as April. Greece also passed a collective action clause which means creditors ‘volunteering’ to participate in the swap will take a 70-75% net present value loss on their original investment. Ouch! Also weighing on risk markets was the European Union’s announced change to its economic forecast which now calls for an EU recession for 2012. Perhaps the silver lining was the fact German business sentiment marked its fourth consecutive monthly improvement in January, suggesting underlying strength in the main economy in Europe.

In fact, global economic data continued to improve steadily as the week wore on with U.S. jobless claims holding at four-year lows and January’s new home sales exceeding expectations providing more evidence the U.S. housing market may be stabilizing. At home, the Bank of Canada’s Quarterly Monetary Report held the same tone as in past quarters suggesting Canada’s economy is at an inflection point. Governor Carney once again reiterated his warning to Canadians about their excessive consumer and mortgage debt levels.

Energy was a big driver of markets this week. Oil has increased for seven days marking the longest advance since January 2010. Tensions with Iran continue to threaten supplies while the economic data suggests energy demand is poised to pick up. $4/gallon gasoline is often cited as an economic threat where it alters both driving habits and consumer behaviors. Some analysts now speculate drivers will face significantly higher prices at the pump in advance of the summer driving season.

TRANSPORTATION’S FLAT TIRE

With the Dow Jones Industrial average touching 13,000 this week, Dow Theorists are on pins and needles calling for a pull back. The work of Charles Dow and his followers suggests that industrial and transportation stocks need to move in tandem to confirm a market trend. Both have moved sharply higher off the October bottom but their paths have diverged this month. The thinking is the manufacturing of goods and the moving of those goods should be in sync for an industrial economy. If they aren’t, the broad market’s recent trend could be poised to reverse. Year to date, the industrials and transports are up similar amounts but the trading patterns appear to be dispersing especially with oil well above $100 per barrel.

TRADING WEEK AHEAD

On the weekend, G-20 foreign ministers convene in Mexico. The key themes will be policies to ensure global growth sustainability with specific emphasis on measures to address the fragile state of the European member states. Watch for a proposal to increase the size of the IMF’s emergency fund from its current $400 billion in available resources to nearly $1 trillion to raise the most eyebrows at the table.

Investors will focus on Wednesday’s second allotment of the European Central Bank’s three-year Long Term Refinancing Operation (LTRO). The LTRO is credited with the underpinning of the recent stock market rally, and is often equated with the Federal Reserve’s Quantitative Easing program. Last time, 523 banks borrowed approximately €500 billion. This time, a similar or even larger allotment should be viewed favorably by equity markets as it would add further liquidity, and end up pushing government bond yields even lower.

The U.S. economic calendar is weighted towards the end of the week as the month of February comes to an end. Consumer confidence should hit a ten month high given the strength of the January jobs report and the strong correlation between employment and consumer confidence. February manufacturing data will likely come in at or near an eight month high, suggesting continuing momentum in the U.S. economy.

Earnings focus turns to BMO Bank of Montreal, RBC Royal Bank, TD Canada Trust, and National Bank as they report their first quarter results this week. Year over year earnings growth expectations for the Canadian banks are modest (single digit) as the headwinds of slowing consumer loan growth and the ongoing weakness in capital markets will weigh on earnings per share. Bombardier also reports its results (Thursday) with investors likely to zero in on their cash flow results and their 2012 guidance.

QUESTION OF THE WEEK

The Greek austerity deal reached this week seems to suggest there is a great deal of economic misery ahead for the Greek population, especially for the youth where employment prospects are dismal at best. What role will Europe’s demographics play in its future?

Demographics matter a great deal in forecasting growth, and by that extension, for asset pricing. Demographic trends also have the advantage of being far easier to predict than other economic factors. Demographics impact an economy in many ways. The age structure of an economy has implications for its growth rate since a lower dependency ratio of those not working to those who are working is a positive for an economy.

More people are economically productive and economic growth is higher as a result. As well, population growth contributes to GDP growth. This is basically saying if you have a larger population, your economy will be larger too. Globally, demographic trends over the next ten years provide some clear insights (see chart).

Japan’s aging population and low birth rate imply a decade of increasing dependency, higher debt burdens, and a decline in its GDP growth rate.

Spain is the best positioned Euro zone member given its decent population growth and low dependency ratio. The Greek and Italian situation is far more problematic since the population is not growing and is made up of a high percentage of economically non‐productive persons. Keep in mind, macroeconomic issues more than demographics will drive those countries in the short term.

10-year bond yield Debt/GDP Population growth 2015-2020 Dependency Ratio*
Spain
4.995%
68.2
0.37%
46.9
Italy
5.442%
120.1
-0.09%
52.2
Greece
30.169%
165.4
0.03%
49.5
Japan
0.968%
208.2
-0.32%
56.4
U.S.
1.979%
69.4
0.79%
49.6

* dependency ratio = population under 15 or over 64/ population between 15-64

Source: Bloomberg, the World Bank, UN dept of economics

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