May was the worst month this year for global equity markets, and the usual suspects are to blame. The European debt crisis has now embroiled Spain and its troubled banking system. Also, the pre-election polls in Greece are suggesting the June vote remains too close to call.
Perhaps the best indication of Europe’s dysfunction is the negative yield on 2-year German bonds. Investors are paying Germany to hold their capital for two years. Trying times.
Beyond Europe, Chinese manufacturing continues to slow its pace, and it seems the U.S. economy was not as strong in the first quarter as everyone originally believed. As well, evidence shows the U.S. housing market struggles continue and the manufacturing as well as the employment data has been underwhelming this spring.
Unfortunately, the synchronized global growth slow-down is taking place just as several of the world’s key central bank stimuli are set to conclude in the month ahead. Despite the setback for stocks in May, the major U.S. indexes remain in positive territory for the year (in C$ terms) while Canada’s TSX has lagged, down about 4.5% for the year.
Corporate news this week was decidedly more favorable than the macro headlines. Both CIBC and National Bank reported better than expected first quarters with the latter showing enough confidence to bump up its dividend by another 5%. Shares of Canadian technology services company, CGI Group, jumped as much as 19% as they bid €1.7 billion for Logica PLC. The deal would more than double CGI’s sales and interestingly shows a willingness to do business in Europe. Much maligned Research in Motion warned on its second quarter results and hired investment bankers for a strategic review. Investors are asking if the FOR SALE sign is on the lawn yet. RIM shares fell 11% on the news.
Commodities extended their price declines after the U.S. created fewer jobs than expected and Chinese factory output slowed in the month of May. In anticipation of money being added in the form of further Quantitative Easing, gold rallied the most in eight months.
Not surprisingly, the Canadian dollar fell to its lowest level in six months on the weaker global growth outlook.
SPAIN’S PAIN PUSHES UP SAFE HAVENS
Investors are now paying the German government to hold on to their money. That’s not a typo, as the yield on 2-year bunds went negative this week as a sign of how much investors fear the unraveling of the Euro zone. The Federal Reserve’s financial model known as the Term Premium measures investors’ willingness to accept yields below what is considered fair value.
This week, the model hit an all time low of -0.86%, which suggests a couple of things. First, investors are fearful the problems in Europe’s periphery now threaten its core (France and Germany) unless there is strong ECB intervention. Second, global growth fears have crushed inflation expectations back to where they were at the beginning of the year. Central bankers, it’s your move.
TRADING WEEK AHEAD
Investors will likely view the first trading week of June through a decidedly skeptical lens. In Europe, central banks will take centre stage with Wednesday’s European Central Bank and Thursday’s Bank of England meetings.
Both are expected to remain on hold with a wait and see approach in an effort to keep the pressure firmly on the politicians. We remain hopeful ECB President Draghi will lower growth expectations as a set up to a rate cut in July. In the U.S., the Beige Book is the Fed’s take on the economy, and this month it will likely show how oil price concerns have been replaced by uncertainties surrounding the fallout from Europe and the prospect of a year-end fiscal cliff.
Following last week’s weak employment data, traders will pay attention to May’s non-manufacturing data. U.S. services PMI is expected to fall to its lowest level of the year. In addition, U.S. consumer credit likely rose by about $10 billion as credit outstanding rises back to early 2009 levels. Canada’s economic data has continued to waffle somewhat, but the employment situation has been very strong the past two months.
Expect Canada’s May employment data to fall back, commensurate with the declines seen in U.S. payrolls.
In China, no major macro-economic data is scheduled for the week. We will continue to watch for more of the government’s focused easing measures and its latest announcement on the state of and outlook for the economy.
Click below to see how the recent slide in crude oil prices will affect investments.
QUESTION OF THE WEEK
With the recent slide in crude oil prices, what can investors expect?
The global benchmark for oil prices is Brent Crude, which has now fallen to an 8-month low, cracking the $100/bbl level this week. This is from a peak of $128 a barrel set in early March. Several factors have conspired to depress the price of oil and several other commodities recently.
- Crude oil prices have dropped 15% in just one month.
- Copper prices have fallen to a recent $3.40 from $4.50 per pound last summer.
- Iron ore prices have fallen nearly 10% in the past month.
A recurring recession in Europe has precipitated a slowdown in Chinese manufacturing and the Chinese economy. At the same time, North American data on the economy has been ebbing and flowing for the past year which is symptomatic of a modest, sub-par growth trend. The weak global growth profile has combined with ample crude supplies, nervous investors, and a stronger U.S. dollar.
Another reason may be the fact negotiations between the West and Iran over the latter’s nuclear ambitions have progressed slowly, but at least without drama. The easing of tensions has taken some of the pressure off prices that had been factored in earlier this year. On the production side, output was deliberately raised to counter the threat of oil loss from Iran.
The International Energy Agency estimates Saudi Arabia pumped 10 million barrels per day in April, their highest output in 30 years. Meanwhile, in the U.S., crude stocks have surged to over 382 million barrels, the highest level since August 1990.
Is this a trough or will it fall further? For traders, the next few days will be critical to see if crude can find any buyers. With most technical support levels broken, do not rule out Brent targeting back near $78/barrel. For longer-term investors, lower energy prices are actually supportive of a struggling global economy rather than a hindrance.
As well, patient investors may view the fact most strategists are now bearish of oil as a buying signal. The facts that growing emerging market demand continues (despite China’s current slowdown) and new oil deposits are logistically more difficult to access suggest bullish longer-term fundamentals for oil remain intact.
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