Barron’s June 4th 2011 investment newspaper ran a great article by Michael Santoli who described the US quantitative easing situation as follows:
In typical fashion, stock investors are dreaming of more candy, while bondholders fret over the cavities and calories that more stimulus could cause. Harris (Chief Economist at Bank Of America) says that equity types are asking when QE3 will come, fixed-income investors when the Fed will tighten monetary policy. His answer to both: “Not this year.”
Corporate profits remain strong, macroeconomic numbers are softening, stocks remain not far off a multi-year high and stubborn fears of a recession relapse in the air. What will happen after the second round of US stimulus, known as QE2?
We asked one of our investment managers, Bruce Campbell, for his comments on the market overall and the issue of further stimulus:
The mild market correction of the past few weeks has deepened as global growth worries abound. The end of QE2 has investors worried. We are keeping our gold holdings high, will consider raising our cash levels, reducing energy and technology weights. Having a bit of cash to invest during dips through the summer makes sense.
The month of May resembled the month of April in terms of its trading pattern. Both months started up, dipped in the middle and recovered over the last two weeks. There was a significant magnitude to the swings but both months finished down modestly relative to the volatility. In fact, May probably would have finished flat with slightly stronger banking results in the last week – more on those shortly. The TSX closed the month at 13,803 which is up 360pts from the start of the year which is 2.6% or 3%+ when you incorporate dividends.
We started the month with the end of Bin Laden, the start of a Harper majority government, new COMEX leverage rules and better than expected job numbers. This was followed by the arrest and subsequent resignation of Dominique Strauss-Kahn, head of the International Monetary Fund. Unfortunately this occurred at a time when Greece is struggling with austerity plans, Italy was warned that its credit rating could be downgraded and Spain’s ruling party suffered a major hit in elections. It now appears that French Finance Minister Christine Lagarde is a lock as Strauss-Kahn’s replacement. In addition, it appears a Greek bailout plan is to be finalized by the end of June apparently without a restructure.
Closer to home, the Big 5 Banks reported weaker than expected quarterly numbers over the past month. All of the banks were hit by weakness in their domestic retail banking segments. This suggests that consumers are making a renewed effort to manage down debt levels. A softer housing market further pressured residential secured lending. Commercial lending was generally strong but not sufficient to compensate for the margin pressure from the retail. As a reminder, all five banks have important domestic operations but they also have an international strategy. The international strategy of TD, Royal Bank and Bank of Montreal is the U.S. – only TD has managed this strategy well and the Royal Bank is in retreat mode. The international strategy for CIBC has been the Caribbean while Scotia Bank has been very successful throughout Central and South America. A balanced portfolio of assets won the day as Scotia’s second quarter far exceeded those of the other four. A ranking of the five based on the second quarter would be: Scotia, BMO, TD, CIBC and Royal.
The Bank of Canada did not raise rates this month and despite stating that rates will have to increase ‘eventually’, any rate rises will be ‘carefully considered’. The BoC statement in general was very balanced. Inflation is expected to be above 3% ‘in the short term’ but only 2% by middle of 2012.
Hawkish comments that are consistent with a raise sooner rather than later:
- Commodity prices expected to remain high
- Canada’s economic recovery is ‘largely as expected’
Dovish comments that are consistent with no imminent raise:
- Increased risks from ‘peripheral’ Europe … see above
- Canadian economy still has ‘material excess supply’
- ‘Greater headwinds’ from strong dollar
The consensus view is still two raises prior to year end with the first occurring in the third quarter – however, moved from July to September. It is our view that we probably will only see one raise before year end and if we were to assign probabilities it would be 30% September, 60% October and 10% Other.
The US economy is showing signs of relative weakness compared to expectations. Job numbers were very weak in the first week of June. Our very large weighting in gold is helping and feels like we should hold it for awhile longer.
We are at an inflection point where the economy will either re-accelerate with possible QE3 help or will stay soft. We are in the camp of this being temporary and the economy will get back on its weak but positive track starting in the third quarter. We may have front-loaded the correction and we could well climb the wall of worry in the back half of the year.
