As we close out the first quarter of 2015, we have actually seen a soft start to the year with the Canadian markets outperforming our counterparts south of the border. Both the major indices in the United States, the Dow and the S&P 500 have actually delivered negative returns for the first three months of the year, whereas Canada is up a modest 1%.
We mention this as market commentators overwhelmingly predicted the opposite, and that investors should increasingly own international assets versus Canadian. We prefer to hold more of a balance of US, International and Canadian assets, as we believe that over time currency fluctuations balance out over the longer term.
This week we also had the opportunity to sit down with Andrew McCreath from Forge First Asset Management, who many of you may recognize from his frequent appearances on BNN. One of the key takeaways we got from his presentation was that the ratio of the monthly S&P 500 price level to trailing 10 year average earnings, adjusted for inflation, is getting high. In fact, today the S&P 500 is trading at 17.8x forecasted forward earnings per share, which we would consider to be fairly valued. What really got us to sit up and take notice was that since 1976 the only time the S&P 500 Price to Earnings multiple was higher was during the 1999 / 2000 technology bubble.
Even though interest rate hike fears have dissipated since the last US Federal Reserve meeting, other concerns linger. Notably market valuations as mentioned above and a string of weaker US economic data are now the focus as we head into corporate earnings reporting season. With increased uncertainty surrounding the impact of the rapidly rising US Dollar on overseas subsidiary earnings and what this could also mean for forward guidance, we expect to see the recent trend of market choppiness continue.
To elaborate on the US Dollar impact on stocks, we looked at the 1997 and 2006 episodes which were mid-cycle periods of US Dollar strength. In both cases, from the peak in the US Dollar Index, the S&P 500 went sideways for several months; that are five months in 1997 and eight months in 2006. However, the most striking observation is that while a bull-market pause was healthy with the S&P 500 eventually resuming its uptrend and making new highs, the US Dollar did not. This is where it could eventually get tricky for investors if expectations remain that the US Dollar is in a long-term bull market. Should the old saying “history never repeats itself but it rhymes” play out, the word “patience” may also apply to equity investors this year.
Regarding economic statistics this week, we saw both headline and core inflation in the U.S. rise slightly due to a slight increase in gasoline prices and higher home sales. However, durable goods orders declined for the fifth time in the last seven months; moreover, consumer sentiment dropped for the second month in a row. Now should this softness in the economic data persist, we would fully expect to see increased uncertainty with respect as to whether or not the Federal Reserve would even need to raise rates in September, let alone the June meeting. As we have written many times, greater uncertainty means higher volatility in the market.
In Europe, momentum has continued to build, especially within Germany where the manufacturing sector has posted strong growth over the past several months. In last part this is due to the depreciating Euro, which has tremendously aided in the rejuvenation of inflation within the Eurozone.
The above paragraphs are not meant to scare our readers, nor are we saying a significant market correction is imminent. But the current macro environment in combination with current market valuations is leading us to reprioritize our investment thinking and an increased focus on risk management is very prudent. To some of you this will mean a greater use of stop loss orders and for others it will mean a greater utilization of alternative strategies such as market neutral or long/short management styles within your portfolio.
We never forget that working for our clients is an expression of your trust, and we promise to always uphold that trust. Thank you.
As always, we welcome your feedback. Have a great weekend.
The Dekker Hewett Group