In This Week’s Market Observer…
- NBF Asset Allocation Strategy – Emerging market crisis in the making?
- NBFM Forex – Fed’s QE wind down wreaking havoc on currencies
- Deprecation of Canadian dollar: Lifeline for some manufacturing industries
- Retirement Corner
- Week at a Glance
- Reads of the week
- Economic Calendar
- Earnings Reports
Asset Allocation Strategy – Emerging market crisis in the making?
Stocks certainly didn’t begin 2014 following the trend we enjoyed in the closing months of 2013. Following weaker-than-expected data in the United States and rising fears about the outlook for emerging market economies, U.S. 10-year treasury notes rallied strongly during the month, outperforming stocks by the widest margin since 2012. Emerging markets were hardest hit, with a drop of 6.5% for the month. Contagion spread to developed markets, with the overbought S&P 500 falling 3.5% and EAFE regions losing 4%. Thanks to a rebound in gold prices, the S&P/TSX managed to turn in a respectable performance, finishing the month up 0.8% in local currency terms. However, once translated into USD, the S&P/TSX’s returns were more in line with other developed markets as a result of a 4.8% depreciation of the loonie.
Asset allocation strategy
Fixed income: Turbulence in the short run could mean that the demand for safe havens remains high. We recommend maintaining a neutral duration over the next 1 to 3-month horizon. However, with the Fed tapering according to schedule, bonds have limited upside at these levels and the risk of rising yields from now until the end of the year remains. Credit products should continue to outperform government bonds over the 12 to 18-month horizon.
Equities: For both short and longer horizons, we continue to recommend holding developed market equities (US and EAFE) versus emerging market and Canadian equities.
Commodities: Strong technical resistance at the US$1,200 level should permit gold to continue playing its role as a safe haven over the short term, but poor longer-term fundamentals suggest that the upside is very limited.
Currencies: The U.S. dollar should remain on an upward trend. Short-term pullbacks could occur if policy actions are taken to strengthen emerging market currencies. But the gradual tapering of the Fed’s bond purchases suggests that the greenback will continue having the wind in its sails. The path of least resistance for the Canadian dollar is downward.
NBFM Forex (February 2014) – Fed’s QE wind down wreaking havoc on currencies
Given its topical nature, below is an update from NBF’s Economics and Strategy Teams’ Forex report for February.
- The FOMC’s decision to wind down its QE program by the end of the year is lifting the greenback not only because it’s signalling to investors an end to the Fed’s currency depreciation strategies, but also due to the fear/uncertainty such a decision creates, particularly in emerging markets. At this point, the Fed doesn’t seem all too bothered by the recent stress in emerging markets, but that could change, considering the importance of those economies which account for over 50% of global GDP according to the IMF. Regardless, expect the Fed’s actions to continue to foster an environment of heightened financial market volatility.
- Considering the European Central Bank’s surprising lack of urgency in tackling deflation at its January meeting, we’ve pushed by one quarter (to end-Q2) the timeline for when we see the euro dropping to 1.28 versus the US dollar. But the longer it waits, the more aggressive the ECB will have to get later on to tackle the threat of deflation. We continue to believe that monetary policy is about to get even looser this year in the zone, something that’s likely to weigh on the common currency.
- The Canadian dollar was the worst performing major currency in January, losing over 4% in the month and depreciating past our 1.10 end-of-Q1 target versus the US dollar. But we’re in no rush to make room for further depreciation. In our view, market expectations for Bank of Canada rate cuts this year are exaggerated. Moreover, if as we expect foreign investors eventually reacquaint themselves with Canada’s AAA rated securities and superior fiscal standing, portfolio inflows will bounce back, something which together with the unwinding of massive speculative short CAD positions, could be enough to keep the loonie near current levels even as the Fed tapers its QE program.
NBF Research Special Study – Depreciation of Canadian dollar: Lifeline for some manufacturing industries
NBF’s Economics & Strategy team published a special report this week on the Canadian dollar and the impact on Canada’s manufacturing industries that we wanted to highlight.
- The Canadian dollar has been losing ground to the greenback. In the present study, our working assumption is 10% depreciation from its average value of US$0.9630 in 2013Q3.
- The higher an industry’s net exports coefficient, the more its profit margin on operations localised in Canada improves following a depreciation of the Canadian dollar.
- We calculated the net exports coefficient for 82 separate manufacturing industries and 12 industries extracting oil, gas and mineral ores.
- The operations localised in Canada of the computer and electronic products industry have been in the red for the past seven quarters. Starting from operating losses representative of that period, a 10% depreciation of the Canadian dollar would barely return this industry to profitability. Results would be more convincing for pulp and paper mills, as a 10% depreciation of the loonie would push their operating margin to 3.2% from the a situation of a cumulated operating loss over the last four quarters.
- In 2013Q3, the primary metals industry enjoyed a slim profit margin of 0.8%. A 10% depreciation of the loonie would push this margin to 3.1%.
- The loonie’s depreciation has a proportionately lesser impact on the profit margin of the motor vehicles and trailers industry despite the fact that a strong share of its production is exported. Indeed, this effect is offset in part by the fact that a strong share of its inputs is imported.
- Mining and oil & gas extraction industries have in general large net export coefficients. Except gold and silver ore mining and support activities to mining and oil & gas extraction (contract drilling and other support activities except geophysical surveying), they therefore strongly benefit from a depreciation of the Canadian dollar.
Week at a Glance
Reads of the week
Monday February 10th – Canadian Housing Starts
Tuesday February 11th – U.S. Wholesale Trade Sales, U.S. Wholesale Inventories
Wednesday February 12th – U.S. Monthly Budget Statement
Thursday February 13th – Canadian New Housing Price Index, U.S. Retail Sales, U.S. Initial Jobless Claims, U.S. Business Inventories
Friday February 14th – Canadian Manufacturing Sales, U.S. Industrial Production, University of Michigan Confidence
Monday February 10th – Emera, Loews
Tuesday February 11th – Cineplex, Enbridge Income Fund
Wednesday February 12th – Air Canada, Calloway REIT, Deere & Co, Home Capital Group, Rogers Communications, Sun Life Financial, Talisman, Thomson Reuters
Thursday February 13th – Barrick Gold, Canadian Tire, Cenovus Energy, CI Financial, Encana Corp, Goldcorp, Great-West Lifeco, Just Energy Group, Manulife Financial, RioCan REIT, TELUS, Progressive Waste, West Fraser Timber
Friday February 14th – Brookfield Asset Management, Enbridge, IGM Financial