In mid-April, markets began to discount shifts in two key variables that drive investment performance: inflation vs. deflation and the relative prospects for growth in Europe vs. the US. In any short period of time, perception is reality, and that was certainly the case with stocks and currencies during the second half of April. The winners of Q1 2015 suddenly became the losers during the last half of the month. German stocks, the US dollar, and 'defensive' equities suffered sizeable declines, while Brazilian, Russian and basic material equities were examples of losers that became winners. These developments beg two questions to be addressed in this monthly commentary. Is this asset rotation fundamentally sustainable or merely a trade? And second, as we've now entered May, typically a tough month for stocks, will 2015 be a year to 'go away in May'?...
The launch of Europe's quantitative easing program on March 9th will likely be the most important financial event of 2015, but not the only surprise that markets will have to absorb. Draghi’s QE plan is 3 times larger than the Fed’s purchases (relative to the size of government borrowing) and will be equivalent in size to 250% of the total net bond issuance of all Eurozone governments during its currently envisioned 18-month life span. Its impact on financial markets was swift, as sovereign yields went negative, the EUR/USD traded to a 12-year low, and European stocks marched higher as quickly as Japanese equities did post Kuroda's version of 'shock and awe'. Also, March 2015 was another solid month for Forge First, as each fund bucked declining North American indices.
Despite softer than expected Q4 earnings and falling 2015 EPS estimates, risk assets enjoyed robust returns during February 2015 thanks to a stabilization in currency markets. US shares more than recovered their 3.0% January price decline with a 5.8% gain. In fact, February exhibited the strongest monthly advance since October 2011, the best February since 1998, and saw US indices enjoy four all-time closing highs.
The TSX, Canada's principal index, also enjoyed gains in February, though more subdued than those south of the border. Bank shares gained much of their January losses back as fiscal Q1 results weren't as bad as feared. Meanwhile, the Energy subsector climbed 1.3% as oil prices, which touched both US$45 and US$55 during February before closing the month at US$49.30, gained 3.6%. Relentless US supply growth caused natural gas prices to fall despite much of central and eastern North America experiencing the coldest February in over 50 years.
Both of our funds at Forge First continued the strong momentum seen during January....
I don’t want to be an alarmist but if oil prices are still below $60 a year from now, could history repeat itself during the next 18 months? Back in 1997-1998, the price of oil fell 60%, the US dollar surged 40% and Russia defaulted on its debt. A repeat experience would likely deliver a deadlier result to financial markets, as authorities have already pulled out all the stops in their attempts to fight the structural headwinds of high debt and unfavourable demographics. Determining the likelihood of this happening is virtually impossible since words from the powers of OPEC members in the Middle East have so far suggested they’re willing to use their balance sheets to maintain this game of attrition for as long as it takes. The negative scenario would create significant challenges to Canada’s housing market and economy in 2016, creating further downside in many staples of Canada’s financial markets.
On the flip side, if we finally see production shut-ins versus mere deferments of capital spend, and the Saudis assuage to the pressure of their cash starved peers, cut supply and allow the oil quote to breathe into the mid-$60 range, then asset markets could look very different by the Fall. Yields on developed country sovereign long bonds will have reversed a portion of their year-to-date 60 basis point (bps) move, sector rotation will be the flavour of the day in equities, and the Canadian dollar will have gained back several pennies of its 8.5% January plunge against the US dollar. It’s this degree of uncertainty that explains the attractiveness of low volatility, long/short equity funds...