Extent Of Rebound In Economic Activity And Profits Uncertain

The MSCI World index has followed a spectacular January with a further 1.3% climb in February, for gains of 6.6% year to date and 13.5% from the November low. Although the threat of financial catastrophe in Europe has subsided and central banks have been pumping liquidity into the markets, the economic backdrop remains lacklustre.

At the time of writing, with 97% of S&P 500 companies reporting, sales have been anaemic, but the earnings growth has beaten consensus expectations. Earnings of nonfinancials have also beat expectations but by a lesser margin. In North America, even if unspectacular the Q4 announcement season did nothing to shake market confidence.

Energy extraction has become a key driver of U.S. industrial production. This ongoing development, in conjunction with higher Canadian production, has left WTI crude (the North American benchmark) trading at a discount to Brent crude (the world benchmark). An additional challenge for Canadian producers is that the oil surplus is especially large in their usual target market, the U.S. Midwest. Canada’s Energy sector could be behind the eight ball for a while.

Developments in Washington over the coming weeks – negotiations on sequestration – could have a significant impact on future purchases of Treasuries by central banks. If Washington kicks the can down the road again, we think the likelihood of a U.S. credit downgrade will increase significantly and the USD could become vulnerable to foreign outflows. If that’s the case, we think foreign central banks could pull in their horns by adding to their positions in bullion.

Generally speaking, we remain comfortable with our benchmark allocation of 55% equities and 40% fixed income. Equities have become much less affordable, and in our view the market volatility risk is relatively high. Among S&P/TSX sectors, we are lowering our weighting for Energy (from overweight to market weight), raising it for Industrials (from underweight to market weight) and materials (from market weight to overweight).


The MSCI World index1 has followed a spectacular January with a further 1.3% climb in February, for gains of 6.6% year to date (chart 1) and 13.5% from the November low. Yet although the threat of financial catastrophe in Europe has subsided and central banks have been pumping liquidity into the markets, the economic backdrop remains lacklustre. A wave of enthusiasm for equities has unfurled while economic leading indicators were turning up in some regions. Yet, the extent of the rebound in economic activity and profits remains uncertain.

Eurozone growth indicators, for their part, have surprised on the downside. It was no secret that the countries of the periphery were still in recession, but in Q4 the slump spread unmistakeably to France and Germany (chart 2). Japan, meanwhile, turned in a third straight quarter of contraction. Canada may have performed a bit better than its peers, but that doesn’t mean growth was good at just 0.6% annualized.

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