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April 5, 2019


2019 Q1

Overview & Outlook

Market on the Move

We are a quarter's way into the new year and the market has been recovering rather quickly from its recent pullback in December. While financial assets have been holding up well, the US Fed and its actions are hinting to economic concerns, which we will further breakdown. Also in this report, we will take a quick look overseas to see what the developments are in Europe, followed by a short review of Canada's current economic state.

As the markets moved through the beginning of 2019, equities made quite the rebound. While they have not reached new highs, the sharp recovery points to the decisive momentum in the market. However, it wouldn't be abnormal to see another pullback of some sort, so be sure to have some cash on stand-by.

S&P 500 Recent Recovery

2019 Equity Rebound.png

Source: YCharts

Breaking Down the US Fed's Actions

On March 20, 2019 the US Fed announced that they're leaving the Fed fund rate unchanged. Additionally, the Fed intends to begin slowing the pace of its balance sheet sell-off. The Fed's balance sheet has trillions of dollars worth of assets that it has been selling onto the open market, which puts pressure on asset prices. Markets have interpreted this reduced selling as a positive sign for markets, however, I believe this is an erroneous interpretation, and should instead be viewed as sobering news about the Fed's economic outlook.


Here is why: If the Fed isn't increasing rates, it's telling us that it thinks the economy is too weak to handle increases. And if they intend to stop selling off their balance sheet, this means they've hypothesized that the market cannot tolerate the pressure coming from the sell-off.


Lastly, and perhaps the most interesting part of the announcement was its stated intentions with the mortgage-backed securities (MBS) it owns on the balance sheet. In October the MBSs the Fed owns will begin to mature, and consequently it will use the proceeds from the maturing MBSs to fund new purchases of US Treasuries. This is the equivalent of boosting liquidity and loosening monetary policy… and history has proven that the market loves an easing Fed policy and more liquidity.

The Impact Unchanged Rates Have on the Market (S&P 500)

Market Gain.png

Now, in analysing the chart above, it becomes evident that during the period where the Fed kept rates unchanged after a hiking cycle the market climbed from approximately 1250 to 1550 (a gain of 24%). 

In this case, history may serve as a guide to understanding the possible market scenario we're currently in, suggesting potential market upside until the Fed decides to conclusively lower rates - at which point we can expect greater market turbulence and a possible correction.

Source: YCharts

A Glance into Europe

Now moving on to overseas, one key economic data source to closely watch is the purchasing-managers index (PMI). PMI data gives us a feel for what purchasing managers are doing. If they are optimistic and preparing for growing future demand then the index should sit above 50. The chart below shows PMI data for the US, France, and Germany, which is all in decline. While all three countries are decreasing, France and Germany (along with the Eurozone) however, are proving to be weaker than the US. This further enforces my argument on why investment portfolios need to be overweight the US relative to the rest of the world in this current market. 

Purchasing-Managers Index (PMI) for Manufacturing

PMI Europe.png

The weakening environment, principally in Germany, has been leading investors to safer asset classes, such as government bonds. The result of capital flooding safer to asset classes has pushed the German Bund yield lower. The impact of this has also led to lower 10-Year US government bond yields as money floods into the 'safer' US, and has led to a technical yield curve inversion (I'll cover more of this in the next report). Now, these declining yields are putting a hold on the increasing mortgage rate environment we have seen in the last 18 months or so - which is keeping housing markets afloat by preventing mortgage rates from going up.

Coming Back Home

Lastly, let's talk about Canada. Housing activity data for Vancouver this March was released, and the results are worth noting. In terms of sales activity, there has been a 31% decline since March last year with detached homes and townhouses down 27% and condos down 35%. The reason I mention this is because housing data gives us consumer spending insight. When people buy their first house or move into a new one, it is usually followed by increased discretionary spending, such as new appliances, accessories, décor, and supplies. All of which powers our economy by helping business grow. Less people moving around can directly lead to slowing economic activity.


Canada's Q4 2018 GDP growth came in at 0.1%, showing signs of a quickly slowing economy that coincides with housing data. Now going forward, my concern for the Canadian economy also stems from the impending trade deal between the US and China. While a deal between them may ease geo-political tensions, it will likely require China to purchase more goods from the US for the sake of trade, making this the antithesis of Canada's economic needs. If China needs to buy more from the US, then that will form the basis for why China will buy less from Canada. This will ultimately hurt our exports and by extension our economy and potentially the Canadian Dollar. Once again, further emphasizing the need to diversify investments away from Canada.

Putting it all Together

All in all, we may see a small pull back coming as the market has recovered rather quickly recently. However, with the Fed's easing policy, it paves the path for a potential market rally over the next year or so, but take this as bitter sweet since global economic data is beginning to weaken, creating fault lines in the market's overall sustainability. As for Canada, though we may see the housing market hold steady from here for a while, banks may still be the near-term victims of our current economic situation.

Thanks for reading.

Your Financial & Investment Advisor,

Gianluca Folino

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