The news with the economy seems to be going in opposite directions from the stock markets. I can’t help but ask why and try and find an answer.

Let’s look at some economic data first.¬†US retail sales are on a solid uptrend, that’s positive. Inflation across most of the world is extremely weak indicating very low interest rates for a long time which is positive because of the lower interest rates but negative for the lack of upward economic pressure. US Inflation came in just above zero however US manufacturing came in much better than expected, negative and positive respectively.

Chinese vehicle sales rebounded in a major way, positive.

Canadian exports increased while imports remain low which indicates a slower to reopening of Canada but also weakness while we are benefiting from exports, negative overall. Should this trade surplus continue Canada may face backlash from President Trump even in this global crisis as he was threatening aluminum tariffs right before the USMCA trade agreement took effect, again negative. The US had a pretty big trade deficit in May, also negative.

Mortgage rates in the US and Canada continue to drop which indicate weakness but also provides stimulus for the housing sector. This is very positive in Canada particularly because of the percent of GDP that it represents.

How can the markets be so highly valued? Cutting expenses, better margins, lower discount rate, refinancing debt at lower rates equals higher stock prices and higher warranted multiples along with it.

The expectation isn’t about what revenues are doing today but what revenues will do over the next several years. Should revenues severely miss the mark then there will be a selloff.

Keep in mind that the stock market is comprised of very large companies that will not feel a recession as bad as a local smaller company. This is why there is often a disconnect between Main Street and Wall Street.

In addition, the amount of global stimulus is multiples of the amount of stimulus during the credit crisis and it was implemented in record time with many benefits being extended.

Risks come from the government not being willing to provide benefits to the unemployed much longer and a couple months after August there will be cash flow problems if the CERB and US equivalent aren’t extended. Plus a second wave of higher paying jobs to be cut are likely coming as companies will be waiting to cut costs but don’t want to seem insensitive in the middle of a pandemic.

Remember that you are investing in the company that is cutting costs and not the employee who lost their job.

I could see trouble happening for the consumer in December or Q1 of 2021 which would likely reflect in weakness for the banking sector. If this trouble doesn’t come then financials are very undervalued right now. If trouble does come then I think that they are overvalued and would look to buy into Canadian stocks should the default rate in Canada rise and we see more weakness in the Canadian banking sector stocks. Recall that Canadian financials make up about 30% of the TSX.

News still dominates as much of the economic data and is relatively old considering that it is just now reporting on May. One of the more frequent data is the US weekly unemployment claims. It has been extremely volatile recently however the magnitude has been incredible. Four to six weeks ago we saw the number of unemployed hit numbers in a matter of weeks that during the credit crisis took many months to lay off that many people.

While the news has been dramatic, the stimulus has been large and quickly implemented. Central banks around the world have lowered interest rates extremely quickly and weren’t waiting for economic data to make a decision.

Central banks also kept the credit markets functioning and are ready to buy assets to keep them flowing well.

Overall I’m very optimistic over the long term and find value in the US industrial sector. Buying them early last month we experienced a near 10% rise in the first week only to come down to levels we bought them at as there was a bit of negative news coming out.

I reduced the position slightly and put money to work in the NASDAQ which is currency hedged so we won’t be affected by the change in the US dollar.

This is a barbell approach with a tech heavy index in the form of the NASDAQ but also an industrial weighting. The majority of the portfolio remains focused on the US S&P 500 which continues to outperform the TSX.

Until next time,

Trevor Dale, CFA