Central bankers, policy moves in focus
Central bankers were in the spotlight this week with traders taking their cue from policy moves and comments. The most notable action – or inaction – came from the European Central Bank as it stayed the course on interest rates Thursday. The bank did, however, open the door to an extension of its bond-buying program past its current expiry date of March 2017. Also in the euro zone, retail sales figures released Monday jumped 1.1% in July from June – the strongest performance in more than five years. Consensus estimates had called for a rise of 0.5% which suggests Brexit was not as impactful as first suspected – something the ECB mentioned at its policy-setting meeting later in the week. Turning to the U.S., the Institute of Supply Management’s non-manufacturing index fell to 51.4 from 55.5 in July – a figure lower than expected and the lowest since February 2010. The ISM data comes on the heels of a weak jobs report last Friday the impact of which was blunted by a lower-than expected jobless claims print released this week. The mixed data complicates the picture for Fed policy officials who are debating whether and when to raise interest rates. In Canada, the central bank held steady on interest rates Wednesday keeping the overnight rate at 0.5%. The bank’s reluctance to move lower on rates was motivated by its view that there will be a ‘sustained rebound’ in the second half of the year. In China, trade data showed a drop in August exports although the decline was less than the previous month. Imports did, however, rise last month for the first time in two years. Looking ahead, Statistics Canada releases its labour force survey today.
Most large North American stock benchmarks drifted most of the week extending a period of calm that started this summer. For the four-day period covered in this report the Dow fell 12 pts. to close at 18,479, the S&P 500 rose 2 pts. to finish at 2,181 and the Nasdaq moved higher by 10 pts. to settle at 5,259. The TSX moved ahead 8 pts. to end at 14,803 through Thursday close.
Valuations not a reason to be overly bearish on equity markets
Much is written about equity valuations and the seemingly high levels we are currently witnessing in North America, leading many to argue equity returns will have to fall or remain low for several years to correct the overvalued conditions. However, an often overlooked aspect of valuations (ie. PE ratios) is their relationship with inflation/interest rates. If inflation/rates are high, investors are less likely to pay high PE multiples for corporate earnings. The opposite has been true for low inflation/rates regimes such as the current decade and the 1960’s. The relationship between PE ratios and inflation, while not exact, does have inverse tendencies and even appears across countries (on average high inflation countries having lower PE ratios than lower inflation countries).
Overall, we don’t see current valuation levels as a reason to be overly bearish on the medium term equity market outlook. Historically equity bull markets have always come to an end when recession risks climb to significant levels (which are not present currently). We continue to view broader market pullbacks as opportunities to add to equity positions with a bias towards economically sensitive and commodity related sectors/countries (ie. Energy, Banks, Semi’s, Transports, Value, Small Caps, High Beta, Canada, Emerging Markets etc.) as opposed to defensives and bond proxy sectors that are trading at historically high multiples and are crowded in terms of investor positioning.
This material does not include or constitute an investment recommendation, and is not intended to take into account the particular investment objectives, financial conditions, or needs of individual clients. Before acting on this material, you should consider whether it is suitable for your particular circumstances and talk to your investment advisor.
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