I wrote in my posting dated May 17th, entitled Bond rally or feint? Bullish stocks again! the following: “The issue now is does one make decisions based on history or does it make more sense to look through the current ‘correction?’ I’m not a fan of that word correction, but in this rare instance I think its appropriate. As I pointed out in prior discussions…..an adjustment in expectations was inevitable. I’m obviously of the opinion that the market is going to recover. Lower pricing (costs = energy, commodity prices) and re-stocking inventory (autos, electronics) will be stimulative on a go forward basis.”
Honestly, I hate myself for being so right most of the time (insert laugh track here). Everything seemed dismal a month and a half ago, but of course the financial community was spooked by old data reflecting the impact of Japan; and prices (commodities) had risen beyond the ability of businesses and consumers to carry them – for instance in Canada gas prices rose 2% in May alone after surging a combined 13.5% in the prior two months. Food inflation flared up further to 3.9% y/y after a 0.5% increase in May. Slow growth and higher prices…a bad combination.
I suggested looking through the correction, and we’re now witnessing some good news despite the pessimism:
- According to the National Realtors Association, U.S. pending home sales jumped 8.2 in May, with gains spread out across the country (NE, MW, South and West).
- The U.S. manufacturing sector unexpectedly expanded at a quicker pace last month. The manufacturing ISM grew 1.8 pts to 55.3 in June, versus expectations of a similar-sized decline.
When things seem like they can’t get worse, they get better. The only ‘robust’ indicator (ISM) is ticking up, and stabilization in the housing market is the key to U.S. consumer confidence. This is why the stock markets managed to eke out a bit of a rally while investors were sulking over old data.
It’s likely the US market will continue to outperform both Canada and European markets (Asia is anybody’s guess) despite the huge government deficit. Leverage is a bad thing when profits are declining, but acts as a catalyst when profitability (economic growth) is above the cost of borrowing for companies and countries alike. My biggest concern now is Canada’s lacklustre growth rate getting more lethargic….which will be a byproduct of a conservative government’s austerity measures. Another potential disaster will be an even stronger Canadian dollar….hurting competitiveness. Costs (even for resource companies) are in C$, and payment for products are in US$ causing a margin squeeze that will hurt many Canadian businesses.
Another issue I have is investors blindly believing (thanks to the press) that commodity demand will forever outstrip supply (see my previous post concerning energy prices) – yes the imbalance in recent years has benefitted Canada (Australia, South America) disproportionately, but a great deal of mine development has occured to boost metals supply, as well as increased energy capacity thanks to an abundance of capital available to resource companies. Am I exagerating? Mining and Energy accounts for less than 5% of Canada’s GDP, whereas the market capitalization of these sectors is likely north of 40% of the TSX Composite. If the valuation of such a small part of the economy has become so rich, there’s risk.
Offsetting this is the “Sell in May and go away!” which has a sister theory which I call, “Buy in July!” Many resource (especially the juniors) gems have been pummeled with the sector and do have a good chance of rebounding aggressively – stock picking rather than sector betting is the way to approach it. I recall former clients of mine (investment advisors in western Canada) would sell the resource fund I managed every April and buy it back in August – they made a killing every year. They were exploiting this seasonality (this seasonality was the subject of an earlier blog and discussed at length in my book, A Maverick Investor’s Guidebook). So I won’t be surprised by a short term rebound in commodity-oriented sectors, but am convinced the really big returns will be made elsewhere (see graph above – this is why the U.S. market, more broadly based, is already doing better than Canada).
The reason I like the U.S. market better? It’s broadly more inviting. There are signs that corporate profitability is coming around.
If the U.S. consumer is in better shape than most think (see my posting concerning U.S. consumers cutting back more than Canadians); and their housing market has really bottomed, then the U.S. stock market may be poised for a surprisingly strong fall & winter.
The correction, although still prone to upsets (since oil prices remain excessive and inflation worries will dampen investor enthusiasm periodically) has most likely run its course. The possible ‘summer rally’ I expected in earlier commentaries has begun and may have legs – and of course most investors, retail and institutional alike, will be away on vacation and miss the opportunity to make a few bucks. It’s a great time for the rest of us not to waste money on gasoline and perhaps top up those investment portfolios we’ve been neglecting.