JMRD Market Observer for September 18th 2015: NBF FED Policy MonitorSeptember 18, 2015
**September 18th Issue of The JMRD Market Observer**
In This Week’s JMRD Market Observer
- JMRD Strategy Comments
- The JMRD Market Observer Turns 7
- NBF: Fed Policy Monitor – Fed restrained by international developments
- Canada’s Big Six Banks & Energy Services: Maintaining Optionality in Uncertain Times
- PEP – Politically Exposed Person
- JMRD Insurance Corner
- JMRD Basket Corner
- Retirement Corner
- Week at a Glance
- Reads of the week
- Economic Calendar
- Earnings Reports
JMRD Strategy Comments
It was another volatile week on the markets, which seems to be the norm these days. Yesterday’s Federal Reserve (FED) interest rate decision was highly anticipated, with expectations leaning toward no change to interest rates. That was indeed the case as the short term interest rate in the US remained unchanged at 0%-0.25%. After the announcement the market gyrated on either side of break even but Friday proved to be more volatile and most global markets gave up much of their gains from the previous days’ sessions. At the time of writing the TSX was still up this week by about 1.5% where the S&P 500 was essentially flat.
On one hand, keeping interest rates low should continue to benefit the gradually improving US economy, but the tone of the FED language in the ensuing conference call intimated that global economic concerns need to be monitored closely. We have provided more information on the FED’s interest rate decision below.
The JMRD principals will be hosting an offsite strategy session early next week to discuss what all this means for the JMRD Baskets and client portfolios in general. We will have a summary in next Friday’s Market Observer.
The JMRD Market Observer Turns 7
This week marks the 7th anniversary of the JMRD Market Observer (M.O.) – the first edition hit the wire back on September 18th, 2008. The genesis of the newsletter came about because of the increased volume of news, research and information that the investment world was receiving at that time. If you recall, during the financial crisis, there was a flood of market-moving headlines (the same can be said today) and we thought a weekly email summary was a great way for us to keep you apprised of the latest financial developments.
The weekly M.O. is constantly changing. We have added new sections over the years but continue working to improve it. We always encourage feedback so if there are any additional features you would like to see added, or if you think we could tweak other areas please do not hesitate to contact us with your thoughts.
National Bank Financial: Fed Policy Monitor – Fed restrained by international developments
The Federal Reserve left monetary policy unchanged at its meeting today. While it again acknowledged that under-utilization of labor resources has diminished, the Fed highlighted its concerns about developments abroad. The Fed is concerned that recent global economic and financial developments may restrain economic activity and put further downward pressure on US inflation over the near term. For now it sees risks to the outlook for economic activity and the labor market as nearly balanced but it is monitoring developments abroad. There was one dissenter with regards to this decision with Jeff Lacker wanting to hike the fed funds rate by 25 basis points.
Fed’s new projections:
The central tendency forecast for GDP growth (Q4/Q4) is now 2.0-2.3% for 2015 (versus 1.8 to 2.0% previously), 2.2 to 2.6% for 2016 (versus 2.4 to 2.7% previously), 2.0 to 2.4% for 2017 (versus 2.1 to 2.5% previously). The central tendency projections for the unemployment rate were lowered a touch: 5.0 to 5.1% for 2015 (5.2 to 5.3% previously), 4.7 to 4.9% for 2016 (4.9 to 5.1%), and 4.7 to 4.9% for 2017 (4.9 to 5.1%). Inflation forecasts were largely unchanged for 2016 and 2017. The Fed presented for the first time its forecasts for 2018 with GDP growth estimated to be between 1.8 and 2.2% and the jobless rate in the range 4.7 to 5.0%.
Similarly, the dot plots, which present information about how participants feel about the pace of policy firming going forward, showed 2018 for the first time. The majority of participants (14 out of 17) see rates at the end of 2018 at 3.00% or above. For 2016 and 2017 the dots have come down a bit compared to last June. In 2016, the Fed still sees 100bp increase (median), i.e. same as last June, and in 2017 another 125 bp increase is expected by participants. While the median for the fed funds rate at the end of this year was 0.625% in June, it is now just 0.375% (i.e. one less hike than participants had expected back in June). There is still a wide range of views among participants for the coming two years ─ at the extremes, one participant judges the appropriate rate should be negative in 2016 while another participant believes it should be as high as 2.875%. The dispersion wanes over time with consensus growing as we move towards 2018 when rates go to the equilibrium rate (which has been lowered a bit to 3.00-4.00%).
Chair Yellen pointed out that while the recent USD appreciation and lower import and energy prices were creating some downward pressures on inflation, her expectations were that those would be transitory. Thus the FOMC still expects inflation to move back towards 2% over time. This opinion is shared by most participants and is reflected in the dot plot which shows most participants believing that it will be appropriate to raise rates in 2015. Still, Chair Yellen acknowledged that four participants were not of that opinion. As far as financial market developments are concerned, she recognized that financial conditions have tightened, but that should be taken in the context of a domestic economy that has been quite robust. So she does not believe it has significant implications for the pace of policy adjustment in 2016. Chair Yellen mentioned it’s not the FOMC’s job to react to market volatility but it nonetheless needs to understand what is driving that volatility e.g. developments in emerging markets including China. Regarding the timing of liftoff, she reiterated that every meeting is one where a change in policy stance can happen, including October when a hike is possible.
The Fed decided to be cautious by leaving monetary policy unchanged. The FOMC is concerned about international developments which it says risk keeping US inflation low for longer and impact exports negatively. The dot plots have moved down a touch (compared to last June) for the next couple of years because they are starting from a lower base. There are now 13 members that see rates remaining below 2% by the end of 2016 (previously 11). Just 7 participants now see rates at 3.00% or above by the end of 2017 (compared to 8 last June). For this year, there’s just one rate hike according to the plots. While a move in October cannot be ruled out, based on the Fed’s overall message today we now expect the Fed to refrain from hiking until at least December by which time the FOMC could have a bit more confidence that global developments are not derailing the outlook for US growth and inflation.
(Full report attached)
Canada’s Big Six Banks & Energy Services: Maintaining Optionality in Uncertain Times
A timely report attached that looks at Canadian banks and their exposure to the energy sector.
During the Q3 f2015 earnings conference calls for the Big Six Canadian banks, we could not help but notice the preponderance of questions focused on the impact of depressed oil prices on loans to oil & gas producers in oil-producing regions. Following a 52% decline in the price of West Texas Intermediate crude oil over the last year, this hardly comes as a surprise. Much of this concern centres on the view that depressed oil prices are likely to persist for an extended period. At present, for example, forward WTI contracts don’t break the US$50/barrel mark until Nov. 2016, and do not breach the US$60/barrel threshold until June 2020.
Interestingly, an examination of the historical performance of forward contracts by NBF’s Energy Services analysts found that the forward curve failed to accurately predict the range in which oil traded in 82% of the instances surveyed. To reach this conclusion, we employed a straightforward methodology using the last 84 forward curves (from August 2008). We then compared the maximum and minimum range which each forward curve predicted for the subsequent 72 months (six years) to the actual (spot) price of oil over the corresponding six years. The actual price of oil fell within the range predicted by the forward curve in only 18% of the instances surveyed (see Appendix).
We acknowledge that contemporary forward prices tend to follow changes in the forward curve, as we illustrate in Figure 1. In other words, when the spot price of a barrel of oil rises over the course of the trading day, forward prices of a barrel of oil (e.g., 6 months, 1 year hence) also tend to rise. This hardly surprises us – the forward curve reflects a consensus view of market participants based on currently known facts and factors. Many unexpected events, however, occur between the time forward contracts mature and the date of the prevailing spot price. As a result, we would caution investors against conclusively relying on the forward curve as a guide for future oil prices because today’s forward price curve is a poor predictor of tomorrow’s spot price.
PEP – Politically Exposed Person
Increased regulation continues to be a fact of life in the securities industry. FINTRAC (the Financial Transaction and Reporting Analysis Centre of Canada), in an effort crack down on illicit activities in the financial system, is required to know if a Canadian investor is a Politically Exposed Person, or PEP for short. Updating client records is an ongoing process for us at JMRD and as we do so over time, we will be asking whether you are in fact a PEP or not. There is now a section on NBF’s Client documentation piece that requires us to disclose this information.
Please see the attached brochure from FINTRAC for a better explanation of what a PEP is and why it’s necessary for us to document this information. If you have any questions, please do not hesitate to contact a member of the JMRD Team.
JMRD Insurance Corner
In what is the first of a three part series in the JMRD Insurance Corner, we have attached a very informative article discussing cottage or vacation property succession planning within families and the potential tax and estate consequences to consider. Cottage Succession Planning
If you find yourself in a similar situation and would like to discuss your options, please call JMRD’s insurance specialist, Steve Lockner.
JMRD Basket Corner
Dollarama (DOL) – Dollarama will be added to the TSX60 index after the close of trading today
All-Cap Growth Basket
Boyd Group (BYD.un) – Boyd will be added to the TSX Composite Index after the close of trading today
Stella-Jones (SJ) – Stella Jones will be added to the TSX Composite Index after the close of trading today
U.S. Growth Basket
Hansebrands (HBI) – Goldman Sachs upgrade HBI to ‘buy’ from ‘neutral’ and increased their price target to $40. The reasons for the upgrade included any “negative organic revenue revisions in the inner wear segment” are transient, not lasting into 2016, and they are encouraged that the company met second-quarter expectations, grew organic earnings before interest and taxes 10%, and maintained its full-year guidance. “Looking ahead, the benefits of lower cotton and buybacks should begin in 2H15 and the core drivers of the bull case — margin expansion and M&A — remain in place.”
Pinnacle Foods (PF) – A recent purchase in the U.S. Growth Basket, Pinnacle Foods announced an 8.5% increase in their quarterly dividend from $0.235 per share to $0.255 per share. This is the company’s 3rd dividend increase since their IPO in March 2013.
- “What you need to know about Old Age Security” (Globe and Mail)
- “A report card for retirement income: What grade does Canada get?” (Globe and Mail)
- “Everything you need to know about the tax free savings account and the federal election” (Financial Post)
Week at a Glance
See Week at a Glance Report.
Reads of the week
- “Utilities stocks get ready for a rebound” (Fortune) Emera was recently added to the JMRD DIG Basket
Monday September 21st – Canadian Wholesale Trade Sales, U.S. Existing Home Sales
Tuesday September 22nd – None
Wednesday September 23rd – Canadian Retail Sales
Thursday September 24th – U.S. Initial Jobless Claims, U.S. Durable Goods Orders, U.S. New Home Sales
Friday September 25th – U.S. GDP Annualized, U. of Michigan Sentiment
Monday September 21st – Lennar
Tuesday September 22nd – General Mills
Wednesday September 23rd – None
Thursday September 24th – Nike
Friday September 25th – Blackberry
Have a good weekend!
Categorised in: JMRD Updates