Volume 23, Issue 41 October 15, 2019.

  Source: Globe & Mail


Thanks U... and U... and U
Douglas Porter, CFA
BMO Chief Economist

Remember all that recent negativity about the big declines in purchasing managers’ reports, trade wars, inverted yield curves, geopolitical risk, and recession fears? Yeah, that was so last week. In a staggering about-face, markets essentially did a mirror image this week, with stocks higher, oil higher, the loonie higher, and bond yields higher. Some of the biggest movers were Canadian bond yields—10s rocketed 30 bps in a week—and the U.K. pound, which pounced almost 3%. That may yet all change again next week, with key developments pending for both U.S./China trade talks and Brexit negotiations, but the tone on both fronts improved markedly in recent days, especially on the latter. Fair warning, this is one of those rare instances when we are faced with some serious event risk immediately after our publication deadline (such a quaint concept from a bygone era… a publication deadline). With that major caveat, here’s a quick list of things to be thankful for this season:

A thaw in U.S./China trade? President Trump is meeting China’s Vice-Premier this afternoon (2:45 pm), and his early reviews of this week’s high-level discussions were positive. As per usual, one must take such missives with a healthy degree of skepticism, shall we say, but there is late word of a partial agreement. The better news comes after a wild week of headlines on everything from a possible currency deal, to investment restrictions, to blacklisting more of China’s firms, and all the way to the NBA and South Park. (Presumably, the CFL and Kim’s Convenience won’t also be drawn into the fray.) Realistically, a limited deal is probably the best we can hope for, but even a stand-down on next week’s proposed tariff hike is a welcome development. After all, the number one concern for investors this year, and arguably the biggest weight on global growth in 2019, has been the ramping up of the trade conflict.
 
Brexit, at last? Perhaps an even bigger surprise was the sudden positive turn in the tone on Brexit. Possibly proving it’s always darkest before the dawn, Thursday’s meeting between the U.K. and Irish prime ministers produced a wave of upbeat talk, and promptly sent the pound on a massive two-day surge. As Ireland’s PM Varadkar said, “there’s many a slip between cup and lip”, but the outlines of an agreement are tantalizingly at hand at the midnight hour. Again, this could change in a heartbeat or a tweet, and we will find out quickly as the EU Summit is this coming Thursday and the October 19 deadline for an agreed deal for the U.K. parliament looms.

USMCA threads the needle? While the China trade talks and Brexit are dominating investor concerns, the Canadian and Mexican economies have been caught in limbo for a year, awaiting approval of the USMCA. Even here, the tone was much better this week, as House Speaker Pelosi continues to talk up the deal’s prospects, and others are now joining the bandwagon. How can that possibly be, with such a deep partisan divide in Washington? The main line of reasoning is that the Democrats want to display that they are still governing (i.e., not consumed by the impeachment inquiry), and many view the USMCA as a low-cost, even popular, means to show that. On this front, we should know the pact’s fate by U.S. Thanksgiving. Markets seem hopeful; it’s likely no coincidence that the Canadian dollar and the Mexican peso have seen the best gains in the currency world so far in 2019.
 
Canada’s non-stop jobs machine? One of the reasons why the loonie is off the mat and Canadian yields rose even more forcefully than U.S. Treasury yields this week was a run of robust domestic data. First, housing starts and building permits posted strong readings, all but confirming that the housing market is back on firm footing. Next week’s existing home sales report for September will likely reveal double-digit gains from year-ago levels, reaching across much of the country. But the kicker was yet another ripping jobs report, with a crackling 70,000 rise in full-time employment and a two-tick drop in the jobless rate to just 5.5%. While the rapid job growth (now 2.4% y/y) hasn’t translated into big gains in spending or GDP growth (just 1.3% y/y), it still reinforces the point that the economy is chugging along and doesn’t appear to be in any great need of assistance. No doubt, that’s the message the BoC is hearing, and already low odds of a near-term rate cut in Canada have faded further.
 
A more normal yield curve? While yields flared higher across the curve, we are seeing some semblance of normality returning to the bond market. Yields on 10-year Treasuries snapped back up by 22 bps this week to 1.75%, which has them now well above 2-year yields (1.60% as we speak) and now even back above 3-month T-bills (1.68%). A Friday announcement by the Fed that they plan to buy $60 billion in bills had little impact. Thus, the great inverted yield curve scare of 2019 may have faded.  Canada is more of an outlier on this front, with 10-year yields still roughly 10-to-15 bps south of 2s and 3-month bills, although this week’s massive move in long-term GoC yields made conditions a bit more normal.
 
Quiet markets for the entire campaign? With just over a week to go in the federal election campaign, Canadian financial markets have been unusually becalmed, especially given the fact that the outcome remains up in the air. Typically, uncertainty is most clearly expressed in the currency, and the Canadian dollar has been quiet, with some modest firming (driven mostly by solid economic data, not politics). Some also may reflect the lack of movement in the polls since Day 1. That may yet change, with some interesting results still quite possible; with such a tight race, any reaction may unfold only on October 22.
 
A positive October? After a rocky start, stocks came roaring back in the second half of the week on the run of upbeat news, and are now broadly up so far this month. Let’s just say that October has a reputation when it comes to equities—in the past 40 years, the two single worst months were both in October (1987 and 2008), and we’re far too polite to reach all the way back to 1929. However, we would also note that the single best month of recent decades was also an October (2011), and many a correction and/ or bear market have been brought to a halt in this fateful month. Despite its wild and woolly reputation, both mean and median gains for the S&P 500 in October over the past 40 years are in fact above average. That trend looks to continue, assuming the news after our deadline doesn’t provide nasty surprises.
 

Have a great week.

Frank & Mark




Source: Globe & Mail, BMO Capital Markets, Bank of Canada

Canada:

Canada’s S&P/TSX Composite Index underperformed other developed markets, Gains were led by the financials and industrials sectors. Health care once again led declining sectors as cannabis stocks extended their six month-slide due to regulatory difficulties and disappointing revenues. The materials sector fell with lower gold prices, and rising bond yields pressured utilities and staples. Year-to-date, the TSX is up 14.6% and the benchmark 10-year yield ended the week to yield 1.51%.

U.S.:
Equity markets rebounded sharply late this week on the back of a number of non-data developments. China-U.S. trade talks took an optimistic turn, the prospect of a Brexit deal emerged out of nowhere, and the Federal Reserve moved to increase the size of its balance sheet again, agreeing to purchase $60 bln of T-bills per month in response to market dislocations.  It should come as no surprise that utilities and REITs have absolutely feasted on the plunge in global bond yields and central bank easing. U.S. utilities are up more than 20% over the past year, leading all sectors in the S&P 500.  Year-to-date, the S&P 500 is up 18.5%, the Dow Jones Industrials is up 14.9%, and the Nasdaq is up 21.5%.  The yield on the 10 year Treasury closed at 1.76%.




Source: BMO Capital Markets 

The Good:  Employment +53,700 (Sep.); Jobless Rate -0.2 ppts to 5.5% (Sep.); Average Hourly Wages +4.3% y/y (Sep.); Building Permits +6.1% (Aug.); New Housing Price Index +0.1% (Aug.).


The Bad:  Housing Starts -2.5% to 221,202 a.r. (Sep.).