EQUITIES COMMENT: "MIXED SIGNALS"
Stocks continued to retrace the 2018 fourth quarter decline and in North America, reached record highs. The TSX Composite was up 3% while the S&P 500 and MSCI EAFE (international stocks) rose 2% in Canadian dollar terms. Despite plenty of weaker economic data, stocks gained on signs of a trade “truce” between the U.S. and China as well as expectations for declines in interest rates.
Statistics released from the U.S., China and Europe during the second quarter indicated a slowdown in manufacturing and trade. Much of this is due to the uncertainty caused by the protectionist trade stance of the U.S. This is dampening business investment. In addition, the tariffs that have been implemented are acting like a tax which hurts economic growth. The good news on the economic front is that the consumer segment of the economy is sound in most regions with low unemployment being a strong support.
After trade negotiations fell apart in May, Trump and Xi agreed to talk at the G20 meeting in June. While no deal was reached, the U.S. postponed the implementation of new tariffs and China agreed to buy more agricultural products. Further negotiations are scheduled. Even if a deal is reached with China, trade issues could linger. Trump has threatened to implement tariffs on European autos in November.
Central banks have indicated they are ready to support the economy while trade uncertainty continues. Declining interest rates should boost economic growth and corporate earnings. Lower rates increase the relative attraction of dividends. As you can see in the previous chart, the U.S. 10 year government bond yield has declined over a full percentage point since October of last year and is now (2.05%) only slightly above the dividend yield on the S&P 500 (1.91%). In Canada, the dividend yield (3.1%) remains above the ten year bond yield (1.7%).
For the first half of 2019, all sectors of the Canadian and U.S. markets have positive returns of 8% or higher with Technology the top performer. During the second quarter, performance was mixed. In Canada, the best sector was Technology. The leading stock was Shopify with a return of 43%. This company provides online retailing solutions for small and mid-sized businesses. Sales are booming as it expands internationally however, it is operating at a loss. The worst performing sector was Health Care. The marijuana stocks were down due to disappointing sales, poor earnings (or lack thereof) and supply issues. The leading U.S. sector was financials and energy was the weakest.
Looking forward, we are sticking with our year end targets of 17000 for the TSX and 3000 for the S&P 500. While recent economic softness could result in reduced earnings growth, lower bond yields are supportive of higher stock valuations. This suggests modest returns of about 4% over the balance of the year. A correction during this time could occur due to disappointing trade developments, a hard Brexit and/or an escalation of the tensions between Iran and the U.S.