Canada’s main stock index fell for a 2nd day in a row yesterday as oil and gold prices dropped and new U.S. data highlighting a steep drop in U.S. durable goods orders last month added to investor fears of a weak economic recovery (more like a U then a V). The energy sector which accounts for about 22% of the value of the over all stock market, was the biggest drag, falling 2.77% after U.S. data showed an unexpected rise in crude inventories, which triggered the biggest slide in the price of oil since April. The mining or materials sector fell 1.74%, hurt by a significant drop in prices for gold and other base metals.
The S&P/TSX composite index finished down by more than 100 points again or 1.1% with 6 out of the 10 main sectors declining. However, oil prices dropped nearly 6% to near $63 a barrel after data showed a surge in U.S. crude inventories on higher imports and lower refinery activity. Crude stocks in the United States which is the world’s top consumer jumped 5.1 million barrels in the week to July 24, according to data from the U.S. Energy Information Administration, countering analyst expectations for an inventory drop (lot’s of short-term supply).
Over the past 4 weeks, U.S. fuel consumption dropped 4.1% against year ago levels. Optimism an economic recovery has helped push crude prices up from below $33 a barrel in December, with investors looking toward positive economic data for signs of a turnaround in flagging oil demand. Falling demand due to the recession has pulled crude prices off record highs near $150 a barrel hit last July, ending a six year rally in commodities that had been fueled by rapid growth expansion in emerging economies such as China and India. The wide swings in prices has raised concern over speculation in commodities markets, prompting the U.S. Commodities Futures Trading Commission to consider implementing position limits for some commodity futures. The price swings by more than $100 a barrel yet demand only swings by +/- 5%. A senior analyst for the International Energy Agency said volatile oil prices may have reached a floor. “The evidence so far suggests that prices have probably reached a floor which may be around $50 to $60,” Eduardo Lopez told Reuters.
In the United States U.S. stocks fell on Wednesday as investors worried that China might be ready to hit the brakes on lending, a move that could curb demand and hinder the global economic recovery which China is supposed to led. Concerns about China compounded the decline in commodity prices. China has been a big driver of part of the global recovery and slower growth in China’s economy could limit upside globally and create downward momentum. China’s two biggest state owned commercial banks have constrained their 2009 lending targets a move that will significantly slow overall Chinese credit growth in the year’s 2nd half (less money in motion constrains growth).
The Dow Jones industrial average declined in value by 0.29%, the Standard & Poor’s 500 Index declined by 0.46% and the Nasdaq Composite Index declined by 0.39%. Each of the three major U.S. stock indexes gained 11% in the previous two weeks as upbeat corporate earnings gave a second wind to a rally that drove the S&P 500 up 40% from a 12 year closing low hit in early March 9th to June 11th. After the big run investors get a bit more defensive as stock valuations continue to expand.
The pace of the recession has slowed or stabilized in most areas of the United States, the Federal Reserve said in a report that pointed to protracted job market weakness even as the economy transitions to recovery. Labor markets across the country were “extremely soft,” with little upward pressure on wages, the Fed said in its Beige Book survey of economic conditions through July 20th. Wages and compensation were steady or falling in most areas, said the Fed which is the U.S. central bank.
The Fed has slashed benchmark interest rates to near zero and pumped hundreds of billions of dollars into the economy to counter the worst financial crisis since the Great Depression of the 1930s.
Fed officials say they expect growth to return in the 2nd half of the year, but warn they expect the recovery will be soft and high unemployment will persist for a while. The Fed has promised to keep benchmark rates exceptionally low for an extended period and to keep its supportive policies in place to support the fragile turnaround.
President Barack Obama launched a spirited defense of his economic policies, declaring that they had helped save the country from plunging into a depression. The President said bank and auto bailouts and stimulus spending were necessary to stop the economic bleeding. “We may be seeing the beginning of the end of the recession” he said, speaking at a campaign style town hall meeting at a North Carolina, Obama took on Republican critics who say his $787 billion economic stimulus plan has failed to prevent the jobless rate from rising to 9.5% at this time.
On March 9th investors believed the global economy would head into a depression with the nationalization of Citigroup and Bank of America (BofA) and either directly or indirectly the U.S. government would control 80% of the U.S. residential mortgage market. This did not happen, in fact the financial system stabilized, credit markets thawed as banks are again lending to some degree to consumers and business (in fact, CIT Group and major regional banks in Texas have either declared bankruptcy or could easily declare bankruptcy and it the news goes largely unnoticed), the auto sector has stabilized or at least bottomed out and the same for the U.S. residential real estate market. In turn, stocks have rallied and companies are beating their earnings targets. Things are pretty good considering what the alternatives could have been. However, investing in stocks is not riskless, valuations are higher and stocks have recovered about 50% of their losses in a period of about 5 months and are still a good 30 to 40% of their respective life time highs. In turn, unemployment is still high and commercial real estate (in the United States) is still fragile.
In short, there is always something to be worried about but time in the market is more important than timing the market and many investors who could either choose to invest in a bond yielding 2 to 3% will likely allocate a portion of portfolio to a riskier investment because the ‘risk’ premium for investing in a risky investment is still high from a historical perspective (see charts below – please note the earnings yield is equal to the one divided by the price to earnings multiple of the stock market, a company that generates no earning growth will see their stock price appreciate by their earnings yield, less dividends).
Investors are currently, assuming that we will not be in a depression just a very bad recession but at some point things will get better and if that assumption is correct investors will be well rewarded for owning a riskier investment.
Regards,
Wilfred Vos Bcs, FMA, CIM, CFP, FCSI, DMS, CBV, MBA, CFA
SVP & Partner
