Recent market volatility isn’t necessarily all bad news…

Recent market volatility isn’t necessarily all bad news…

With the end of quantitative easing in sight, we remain optimistic on equities and concerned about bonds:

• On June 19, Ben Bernanke and the members of the Federal Open Market Committee (FOMC) signaled the tapering of bond purchases by the U.S. Federal Reserve.
• The statement triggered the biggest two‐day decline in stocks in the last few years. However, in our view, the tapering of bond purchase means that the economy is improving. If the economy is improving then that will be good for corporate earnings and therefore good for stocks and commodities, and bad for bonds and gold.
• We believe the correction we have been expecting is currently underway and this will soon represent a good buying opportunity. We remain optimistic on the outlook for equities, continuing to prefer the U.S. over Canada for the balance of 2013.

Tapering is coming:

• The increase in bonds yields after the June 19 FOMC statement was no surprise as one of the largest buyer of bonds since the recession has just signaled their intentions to slow down the purchases and possibly end the purchases in 2014. With increased borrowing costs due to higher interest rates, the cost of borrowing is outweighing the benefits of holding stock positions with borrowed money and therefore funds that buy stocks with borrowed money decided to sell their stock positions and payback their loans.
• Global equity markets have been declining since Fed Chairman Bernanke’s testimony to Congress on May 22. In this testimony, Bernanke made it clear that the FOMC “is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes.” This 1‐2‐3 punch triggered sharp declines in virtually every asset class, except the U.S. dollar.
• Broadly speaking, improving economic trends bode well for corporate earnings growth, and with valuation still attractive, U.S. equities remain our favourite asset class. In this environment, our preferred U.S. sectors remain Financials, Industrials, Technology, and Healthcare. We expect some additional softness for Telcos, Utilities, REITs, and Consumer Staples.
• Gold has succumbed to the fact that inflation around the world remains subdued and that the U.S. could soon stop “printing money.” Copper and other base metals are flirting with technical support levels as investors re-evaluate China’s economic growth.

U.S. still on recovery path; China’s recovery may be delayed

• Recent U.S. economic data has been mixed but still supportive of an improving trend. Retail sales for May, which provide tangible evidence of improving consumer confidence, were better than expected. In sharp contrast to the U.S., Canadian April retail sales were weak and declined when auto sales are excluded. Headline inflation for May was also lower than expected.
• After weak trade data earlier this month, Chinese manufacturing activity showed further contraction. Based on recent commentary from the new leadership it appears that they are comfortable with the current level of economic growth (7%‐8%). Furthermore, the new leadership has voiced a preference to move the country toward a sustainable growth model by focusing on financial, social, and environmental reforms, and a gradual transition away from an export‐centric economy to a domestic‐centric economy.