FEELING REFRESHED? - Picton Mahoney€¦ · summer, and then resume an upward trajectory in the...

FEELING REFRESHED?

Q2 REVIEW AND OUTLOOK

GLOBAL GROWTH—WITH A NON-GROWTH FEEL

CYCLE HAS LEGS—FOR HOW LONG?

SOME NEAR-TERM SPEEDBUMPS

TROUBLE HERE AT HOME?

STILL MAKING THE CASE FOR STOCKS OVER BONDS

SECTOR OUTLOOKS

2 | PICTON MAHONEY Q2 OUTLOOK 2017

“PMAM” refers to Picton Mahoney Asset Management. PMAM view is relative to the Bloomberg consensus estimate for each category.

View PMAM vs. Consensus

Risk Macro risk remained extremely low in the quarter. It will likely go up again at some point this year, but remain subdued due to positive global economic momentum. As a result, the VIX Index hit a near-all time intra-day low of 9.37.

Higher Risk

Macroeconomic

Global Real GDP Global growth remains resilient and estimates have increased. Europe and Japan have surprised to the upside, while Brazil and Russia have shown signs that their recessions are over as EM rate cuts continue. The ECB has managed to extend its accommodative policy for even longer, while the Fed’s tightening remains slow and cautious.

Higher

US Real GDP Even though Q1 has been the weakest quarter seasonally for the last 10 years, fixed asset investment jumped to its highest level in years, showing that the spike in corporate confidence is indeed resulting in higher investment.

Higher

Canada Real GDP Canada’s economy remains precarious. On the one hand, the strength of the U.S. economy has helped bolster Canada, and a weak currency has helped with exports. But commodity prices remain subdued, and risks centre around a housing slowdown that can lead to much higher unemployment. The Bank of Canada (BOC) seems overly optimistic as it prepares the market for a hike this year, which could tip debt-weary Canadians over the edge.

Lower

US Inflation Our U.S. CPI scenario analysis shows that inflation will likely keep falling until mid-summer, and then resume an upward trajectory in the latter half of the year.

Lower

Equity Returns

US Equities U.S. equities continue to make new highs, led by the usual gang of fast-growers that dominate their respective industries. Pullbacks remain fleeting as measures of volatility reach extreme lows. High confidence across consumers and corporate leadership should continue to translate into higher spending, employment and capital investment.

Bullish

European Equities European equities look less risky at the margin compared to last quarter: the French election outcome was benign, Greece received its bail-out funds, Brexit is finally hurting UK more than Europe, and the refugee influx is helping raise inflation and domestic demand. While the currency has risen somewhat, levels remain relatively low while leading indicators remain elevated.

Same

Canadian Equities The seeming resolution of the Home Capital situation will help stabilize the Financials sector, but downside in commodities will hamper Canadian equity returns. Risks from the Real Estate sector remain high.

Bearish

Bond Yields

Treasuries (US 10 yr) 2.5% is a reasonable target for Q3 once inflation numbers start rising again and oil prices stabilize.

Same

Investment Grade Corp Falling rates make corporate bonds look more attractive, but tight spreads limit upside.

Same

High Yield Corp High yield corporate spreads remain near extreme lows, though absolute yield levels still make them relatively attractive. Further downside in oil prices will likely have an impact on the sector and reverberate into other high yield sectors.

Same

Other

WTI Crude Oil The recent surge in shale oil production continues to surprise and subvert OPEC cuts, driving oil prices lower despite a clear peak in U.S. inventories. Still, we expect $45-55 to be the trading range for the latter part of the year once global demand catches up.

Same

EPS Growth (S&P 500) As EPS growth surges to 20%, the next leg is likely lower on falling pricing power and rising wages (lower margins).

Lower

P/E (S&P 500) While multiplies got ahead of earnings last quarter, there has been enough catch-up now that consensus P/E in the high teens seems like fair value.

Same

PICTON MAHONEY Q2 OUTLOOK 2017 | 3

OVERVIEW

IN OUR Q1 2017 OUTLOOK, WE ARGUED THAT CAPITAL MARKETS WOULD UNDERGO A “PAUSE THAT REFRESHES.” MARKETS HAVE PARTIALLY REFLECTED THIS VIEW GIVEN THE PULLBACK IN GLOBAL INTEREST RATES AND THE ROTATION AWAY FROM MORE CYCLICAL STOCKS TO MORE INTEREST RATE-SENSITIVE NAMES. HOWEVER, INSTEAD OF CHECKING BACK, GLOBAL EQUITY INDICES REMAIN NEAR THEIR HIGHS, REFLECTING MORE OF A “GOLDILOCKS” SCENARIO WITH CURIOUSLY SUBDUED VOLATILITY. WE STILL BELIEVE THERE IS POTENTIAL FOR A PULLBACK, BUT OVER THE LONGER TERM WE EXPECT MORE OPPORTUNITIES TO COME IN EQUITIES (ESPECIALLY OVER BONDS).


SECTION 1

SECTION 1 GLOBAL GROWTH—WITH A NON-GROWTH FEEL


Filling gaps – markets quick to reflect the need for pause

Following the U.S. election, rising interest rates appeared to discount better global growth prospects and a normalization of aggressive monetary policies from many central banks worldwide. However, numerous gaps began opening between “hard” (economic) and “soft” (sentiment) data, the result of which begged for a pause to refresh risk/reward metrics in capital markets. One such divergence was between economic surprise indicators and actual U.S. GDP growth. However, that gap has reversed itself today, as U.S. economic surprises are at their lowest in a year while GDP growth tracks near its highs of the past few years (Fig. 1).

Rather than consolidate gains, global equity indices continue to show a spring in their step, but the sectors and themes that are driving returns are far from classically cyclical. In Europe for instance, growth expectations have been stubbornly low, so while economic growth and inflation have surprised on the upside, it is curious that the follow-through in equities has a distinctly “non-growth” feel to it. Is this the re-assertion of the deflation narrative of the past 3 years? Are market participants conditioned to believe that good news must be sold? Or is this just a continued reflection of the thirst for income among the growing retiree demographic?

Pause, refresh, re-accelerate nonetheless

The evidence supports an eventual re-acceleration and there is even some potential that we are still early in the cyclical recovery. In 2015, a broad industrial and trade recession had some impact on the global economy. Industrial production bottomed in early 2016 and has been recovering in the U.S. (and globally) ever since (Fig. 2). This looks very much like an early-cycle growth leg: global trade should continue on its positive trajectory, as per the numerous surveys we track. There is a solid cyclical underpinning to the global economic growth story.

While U.S. Q1 GDP appeared weak, this continued a seasonal pattern that has been in place for the last 10 years (Fig. 3). We expect GDP will bounce back as the rest of the year progresses.

SECTION 1

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

2017-to-date Past Year Past Three Years Past Five Years

Relative Returns to the Highest Quintile of Capital Spending Growth

US Large-CapsUS Small-Caps

-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17

Atlanta Fed GDPNow Forecast (lhs)Citi Economic Surprise - United States (rhs)

5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%

Usual Weekly Earnings: Full Time Wage & Salary Workers

25th percentile 75th percentile

1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017

iShares MSCI Brazil ETF Flows

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998

US Employees On Nonfarm Payrolls By Finance Insurance Real EstateSTCA Canada Finance Insurance Real Estate and Leasing SA

0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD

US Trade Balance With Canada US Trade Balance With Mexico

-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%

Contribution to Real GDP, Fixed Investment (lhs)

Philadelphia Fed: Six Month Capex Forecast (3m MA, rhs)

400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

NAHB Housing Market Survey 96m lead (lhs) Building Permits (rhs) Housing Starts (rhs)

lack of confidence, labour shortage

renewed surge in confidence

-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.52010

2011

2012

2013

2014

2015

2016

2017

Europ FX Net Non-Commercial Combined Positions 9% of Open Interest (rhs)Euro Currency (lhs)

42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Commercial & Industrial Loan Growth (Q/Q%) CEO Con�dence Index

-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY

Largest liquidity injection since pre-New

Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Probability of Hike (Dec 6, 2017)

-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180

Days from ISM Manufacturing Peak

25th/75th percentileCurrent (as if Feb ISM is peak)

Median

Fig 1: U.S. GDP growth estimate vs economic surprise

Source: Bloomberg LP, PMAM Research. As at June 5, 2017.

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 2: Industrial production recovering

Source: Bloomberg LP, PMAM Research. As at May 31, 2017.

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 3: Average U.S. GDP per quarter (Q/Q % SAAR)

Source: Bloomberg LP, PMAM Research. As at March 31, 2017.


SECTION 2: CYCLE HAS LEGS—FOR HOW LONG

Early or late, new or extended, we believe this economic cycle has room to go. The yield curve remains one of the best markers for the economy and a positive slope (short yields lower than longer yields) tends to support growth. Based on our work, the current slope of the yield curve suggests the probability of a recession within the next year is a scant 5%, supporting the truism that recessions don’t just happen, the central bank creates them (via monetary policy).

The U.S. Federal Reserve (the “Fed”) can proclaim “mission accomplished” on jobs. After years of sizable gains in payrolls, the U-6 measure of “underemployed” has returned to pre-crisis levels. Continuing claims for unemployment benefits (adjusted for size of labour force) show the tightest labour market since 1970. On average, recessions occur about three years after full employment has been reached and we are currently only three months into this process.

The Fed’s policies have done wonders for household balance sheets and bolstered incomes, which bode well for future consumption. If a revised health care plan can be passed, the potential to free up more discretionary spending is real, as health care costs are a record high 17.5% of personal expenditures. Some of the “gaps” we noted in our last quarterly outlook related to Trump’s ability to push his agenda. Despite a lack of legislative success to date, not all of his agenda is flawed. Infrastructure and tax cuts (now likely pushed into 2018) should provide a boost.

After the housing bust, it has taken a long time for confidence to rebuild in the sector. The housing cycle has also been constrained more recently due to labour shortages given the amount of labour tied to housing in the previous cycle that had to “repurpose.” However, these trends may be changing. Fig. 4 suggests housing confidence is surging again. At the June Deutsche Bank Materials Conference, 20 building sector companies in attendance were generally positive on demand trends, indicating that 2017 may be the first recovery year since 2012 with no summer slowdown and labour pressures surprisingly abating. Furthermore, the most recent SentriLock report (measuring lockbox activity) for May showed a 13.8% surge in foot traffic.

SECTION 2

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 4: Homebuilder confidence surging


BASED ON OUR WORK, THE CURRENT SLOPE OF THE YIELD CURVE SUGGESTS THE PROBABILITY OF A RECESSION WITHIN THE NEXT YEAR IS A SCANT 5%


SECTION 2

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 6: Market rewarding companies that spend

Source: Empirical Research Partners. As at June 1, 2017.

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 7: Speculator Positioning in Euro vs EUR/USD Spot


-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 5: Forecast capital expenditures vs fixed investment as a share of GDP


Capital spending on the rise

Jobs and wage gains bolster consumer confidence, but the parallel increase in “animal spirits” in CEOs is also noteworthy. There are now early signs that the post-election CEO confidence surge is translating into higher capital spending, as seen in the Q1 GDP report and other hard data points (Fig. 5).

The market is also finally rewarding companies that are spending. As shown in Fig. 6, stocks which rank in the top 20% on capital spending growth are doing far better than they have in years.

Rest of world picking up steam

After years of turmoil, Europe is decidedly on the mend. Having remained extremely accommodative throughout, the European Central Bank (ECB) has managed to forestall the end of quantitative easing, but appears to have reached “escape velocity” with better inflation and growth. At 1.9%, Q1 GDP was on par with U.S. GDP. Leading indicators, such as the IFO Germany Business Expectations survey surging to multi-year highs, and the Sentix Eurozone Economic expectations index at 10-year high, support future growth prospects. Real economy (hard) data around manufacturing is robust: Germany’s Manufacturing PMI remains elevated at 59.3, while France and Italy are out of the woods at 55.0.

The political environment looks much less risky at the margin compared to last quarter following a benign outcome to the French election and the silencing (for now?) of Euro-skeptics. The new French government has even started talks with Germany for further reforms to the union, another unexpected positive. Greece received its bail-out funds and Brexit “light” appears back on the table as the withdrawal appears to be hurting the UK more than the broader region, partly because the refugee influx is contributing to domestic demand and inflation. We forecast that CPI inflation in the region would reach the ECB’s 2% target imminently: it now appears that the ECB is poised to end quantitative easing as this unfolds. After being habitually underweight Europe, global investors have assertively re-allocated capital to the region and speculators are decidedly long the Euro for the first time in three years (Fig. 7).

Having peaked in developed economies, monetary stimulus still has time to play out in less-developed ones. Despite the Fed taking the lead to normalize monetary policy (tapering asset purchases / raising rates), the U.S. dollar is curiously weaker year-to-date. Emerging markets continue to recover from their bout with U.S. dollar strength as it reverses, giving them more latitude to further cut interest rates. Emerging markets’ contributions to global growth is welcome locally and in developed markets alike. For instance, U.S. profits earned abroad grew 25% year-over-year in Q1. As growth in global Leading Economic Indicators continues to trend above 3%, this broader contribution to profits should continue.

AFTER BEING HABITUALLY UNDERWEIGHT EUROPE, GLOBAL INVESTORS HAVE ASSERTIVELY RE-ALLOCATED CAPITAL TO THE REGION AND SPECULATORS ARE DECIDEDLY LONG THE EURO FOR THE FIRST TIME IN THREE YEARS


SECTION 3

SECTION 3: SOME NEAR-TERM SPEEDBUMPS

Despite peaking in February, broad manufacturing activity remains resilient. However, peaks in economic leading indicators, such as Purchasing Manager Indices (PMI), tend to lead to consolidations in equity markets (Fig. 8).

One area where a longer-term peak is likely in place is U.S. motor vehicle production. Vehicles per household are at all-time highs (signaling exhausted demand), while subprime auto loans are showing higher delinquencies. Ford Motor Company is offering buyout packages to 15,000 salaried workers to save costs in North America and Asia where sales are slowing. We should expect some impact on GDP from these steps, although maybe not as much as in past cycles given their smaller contribution to the economy.

Another non-confirming “gap” which is inconsistent with improving economic tone and consumer/CEO confidence is tepid commercial and industrial loan growth (Fig. 9). This may simply be a matter of timing since this data tends to lag the economy by about nine months, or it could be that borrowers are waiting for more signs of stability and execution out of Washington before embarking on major spending programs.

A broader lack of worker availability may be holding back growth potential and could hamper company margins (as labour draws a higher share of profit). No longer a phenomenon confined to “skilled” positions, the labour shortage is now a top concern in the NFIB Small Business survey. Indeed, “unskilled” labour is benefiting: the lowest quartile of wages has enjoyed nearly 6% income growth (Fig. 10).

China’s manufacturing decline

China’s long-term plan is to rebalance its economy away from manufacturing towards consumption. Given the excesses that have been in place, this is no easy task. On balance, the central authority has thus far managed to steer clear of a hard landing, but this has come at the expense of periodic massive stimulus boosts to help shore up the

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 8: Cumulative S&P 500 (TR) into and after a peak in ISM Manufacturing


-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 9: Gap between CEO confidence and commercial loan growth



-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 11: SpaceKnow China Satellite Manufacturing Index in decline

Source: Bloomberg LP, PMAM Research. As at June 26, 2017.-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 12: PBOC open market operations

Source: Bloomberg LP, PMAM Research. (Concept: Charlie McElligott, RBC Capital Markets). As at June 26, 3017.

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 10: Unskilled wage growth on the rise

Source: Bloomberg LP, PMAM Research. As at March 31, 2017.

old economy. A massive stimulus package was underway this time last year which came to an end; we have been concerned about an abrupt slowdown as it worked its way through the system. We may be seeing this now. The Spaceknow China Satellite Manufacturing Index monitors over 6,000 industrial facilities across China and uses proprietary algorithms to measure levels of manufacturing activity. The Index has recently been in steep decline (Fig. 11).

Perhaps this is why the People’s Bank of China (PBoC) has begun to inject cash back into the system (Fig. 12) at the highest rates since the “standard seasonal injection” period prior to the Lunar New Year holiday. Could this be the beginning of a new round of stimulus that helps boost not only China, but the world’s economy?

Perceived Fed mis-step could be the trigger for pullback?

The Fed is intent on normalizing interest rates, but timing—as they say—is everything. The June 14 rate hike into slower inflation may be construed more and more as a policy error, particularly if any signs of slowdown materialize in the near term. Our U.S. CPI model calls for inflation to continue trending downward for a few more months before bottoming. This could coincide with QE tapering in Europe and softer Chinese data, putting added short-term pressure on equity markets that seem very complacent at this time.

SECTION 3

COULD THIS BE THE BEGINNING OF A NEW ROUND OF STIMULUS THAT HELPS BOOST NOT ONLY CHINA, BUT THE WORLD’S ECONOMY?


To say the market has concerns about the Canadian economy would probably be an understatement. Many detractors point to the chief imbalance in our economy: too much reliance on real estate especially when home prices are soaring and unaffordable based on Canadian income measures (interest rates are doing the heavy lifting).

The recent liquidity crisis at Home Capital Group (HCG) increased the level of systemic risk, in our view. As HCG faced a run of nearly 20% of its deposit base over a few days, the fear of contagion risk reverberated across the mortgage finance space. The recent increase in pricing pressure in the brokered GIC market (the major source of funding for the Alt-A mortgage space) should further reduce affordability and partially curb mortgage growth. We believe a slowdown in the Canadian housing market would be healthy. However, if real estate prices are in fact propping up our collective sense of net worth, Canadians should be concerned that the knock-on effects of a housing correction could be more meaningful than expected.

SECTION 4: TROUBLE HERE AT HOME?

SECTION 4

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Recession IP y/y%

-60

-80

-40

-20

0

20

40

60

80

0

1

2

3

4

5

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

15

25

35

45

55

65

75

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016




-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

1

2

3

4

5

6

7

8

9

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1998

1999

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2001

2002

2003

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2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 13: Finance, Insurance and Real Estate Jobs – Canada vs U.S.

Source: Bloomberg LP, PMAM Research. As at April 30, 2017.


SECTION 4

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%




-20

-15

-10

-5

0

5

10

15

20

1945

1950

1955

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2015

Recession IP y/y%

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-40

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Jan-14

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Oct-16

Jan-17

Apr-17

Jul-17


5.7

-1

0

1

2

3

4

5

6

7

2005

2006

2007

2008

2009

2010

2011

2012

2013

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y/y

%



1.2

0.5

2.11.8

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 Q2 Q3 Q4

20172006-20161947-2006

5/19/2017

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2012

2013

2014

2015

2016

2017


-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

2010

2008

2006

2004

2002

2000

1992

1994

1996

1998


0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

20

30

40

-4%-3%-2%-1%0%1%2%3%4%



400

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2400

15

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2002

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2007

2008

2009

2010

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2012

2013

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-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

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2012

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2003

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2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

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2010

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-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

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Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

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Oct-2016

Nov-2016

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Mar-2017

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Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 16: Probability of BoC Rate hike


-3%

-2%

-1%

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-20

-15

-10

-5

0

5

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Recession IP y/y%

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Apr-17

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5.7

-1

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y/y

%



1.2

0.5

2.11.8

1.5

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20172006-20161947-2006

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-8%

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2012

2013

2014

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-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2016

2015

20142013

20122011

20102009

20082007

20062005

20042003

20022001

2000

1991

19901990

1992

19931994

19951996

19971998

1999

2016

2014

2012

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0.054

0.056

0.058

0.060

0.062

0.066

0.064

0.068

-10

-8

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2

$ Bi

llion

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-0.6

-0.4

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1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

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2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

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2016

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2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

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-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

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Aug-2016

Sep-2016

Oct-2016

Nov-2016

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Jan-2017

Feb-2017

Mar-2017

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Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

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Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

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Oct-2016

Nov-2016

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Feb-2017

Mar-2017

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-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 14: % of labour force employed in FIRE Canada vs U.S

Source: Bloomberg LP, PMAM Research. As at April 30, 2017.

-3%

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-20

-15

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-1

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y/y

%Usual Weekly Earnings: Full Time Wage & Salary Workers


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0.42017

2016

2015

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2001

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20142013

20122011

20102009

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20022001

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19931994

19951996

19971998

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2014

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2010

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0.054

0.056

0.058

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0.062

0.066

0.064

0.068

-10

-8

-6

-4

-2

0

2

$ Bi

llion

USD


-20

-10

0

10

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-4%-3%-2%-1%0%1%2%3%4%



400

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-0.8

-0.6

-0.4

-0.2

0.0

0.2

1.0

1.1

1.2

1.3

1.4

1.5

2010

2011

2012

2013

2014

2015

2016

2017


42

44

46

48

50

52

54

56

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

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2006

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2004

2003

2002

2001

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2017201620152014201320122011201020092008200720062005200420032002200120001999199819971996199519941993

-

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1999

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2003

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2005

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2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

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-800-600-400-200

0200400600800

1,0001,200

Billi

on C

NY


Year holiday

0%10%20%30%40%50%60%70%80%90%

100%

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Jul-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017

Aug-2016

Sep-2016

Oct-2016

Nov-2016

Dec-2016

Jan-2017

Feb-2017

Mar-2017

Apr-2017

May-2017

Jun-2017


-16-14-12-10

-8-6-4-202468

-180 -150 -120 -90 -60 -30 0 30 60 90 120 150 180



Median

Fig 15: Post-NAFTA trade imbalances


Canada on “FIRE”

As shown in Fig. 13, Canadian growth in jobs related to Finance, Insurance, Real Estate (FIRE) and Leasing has been eye-popping. Compared to the U.S., which had a meaningful reset after their housing market crashed, we continue to attract human capital to industries whose common link is borrowing to own assets.

FIRE accounts for roughly 6.5% of the Canadian labour force and continues to grow, in stark contrast to the U.S., where the share of labour in these sectors has declined over the past decade (Fig. 14). At this growth rate, Canada’s FIRE index will soon reach the high levels of the early 1990s. For housing market participants, that should ring a bell as loudly as 1987 does for the stock markets.

Sleeping with an elephant

President Trump’s campaign rhetoric seemed negative for Canada, but should be mitigated by the much worse relative trade imbalance that Mexico has with the U.S. (Fig. 15).

As NAFTA renegotiation looms, the continued decline in energy prices certainly isn’t helping to build confidence in the prospects for Canada, especially in Alberta. However, these negatives should be at least somewhat mitigated by continued strength in the U.S. economy and a weaker Canadian dollar. Recent hints from the Bank of Canada regarding earlier rate hikes haven’t helped though. Markets swiftly raised the probability of a December rate hike to over 80% (Fig. 16), while the Canadian dollar strengthened by nearly 2%. It remains to be seen how sensitive the housing market will be to talk (and action) on interest rate normalization, but the risks are sizeable—and the probability of an increase has risen much further as we go to print.


CONCLUSION: STILL MAKING THE CASE FOR STOCKS OVER BONDS

CONCLUSION

While the longer-term backdrop for risk assets is favourable, there are some near-term risks to economic expectations that could cause a pullback in equity markets. Central banks are in tightening mode in most developed markets while inflation expectations have been weakening. China slow-down concerns are real, but any material slowdown as their economy rebalances is likely to be met with yet another stimulus package that kicks the can down the road. Indeed, there are early indications that the PBoC is already beginning to boost liquidity injections into the system in China. Emerging economies have been surprising to the upside and EM bond flows suggest that yield chasers are increasingly confident in the outlook for many EM markets. Countries like Turkey and Brazil are surprising to the upside on GDP.

With ample liquidity still in the system and an improving cyclical backdrop, we expect any pullbacks in equity markets to be bought. Brazil is the recent poster child for such “buy the dip” activity. Political turmoil triggered a 16% drop in the iShares MSCI Brazil Capped ETF (EWZ) on May 18, coupled with significant weakness in the Real and the largest blowout in credit default swaps since the Global Financial Crisis. Despite all this, the following day saw the largest inflows into EWZ in over five years. Perhaps this can be simply explained by the $1 trillion (USD) in relative flows from equities into fixed income since the Great Financial Crisis that need to revert back to equities as the economic cycle begins to gain traction.


SECTOR OUTLOOKS

CONSUMER DISCRETIONARY

We remain overweight the Canadian Consumer Discretionary sector, but are growing increasingly cautious on the space. Despite once again outperforming the broader market this quarter, discretionary stocks began to soften in June as expensive valuations and smaller earnings upgrades following Q1 results led to some profit taking by investors. Though many data points continue to point toward a healthy Canadian consumer, structural headwinds – including the threat of online retail, slowing auto sales in the US, and a weaker Canadian dollar – are persistent concerns for the group. Against this backdrop, we believe that stock selection will become even more important as companies are only rewarded for best-in-class execution.

Our favorite name in the space remains Canadian Tire Corporation, Limited, an underappreciated stock which continues to deliver better-than-expected earnings supported by a robust balance sheet. The stock has pulled back following slightly weaker-than-expected Q1 same-store sales, but this was entirely due to unseasonably cool spring weather. We expect top line growth to re-accelerate as temperatures heat up. The company continues to manage costs very effectively (driving an impressive earnings beat) and the stock continues to look highly attractive with the retail business trading at ~4x EV/EBITDA. BRP Inc. is another stock which is delivering exceptional results, benefiting from disruption to its key competitor, Polaris Industries Inc. Market share gains (helped by strong new products) have been reflected in stronger-than-anticipated revenue and profit growth. We believe there is further upside to earnings, particularly should oil-exposed markets recover from their lows.

INDUSTRIALS

Our Industrials outlook remains the same as last quarter. Macro and business confidence survey data continues to trend better, but has

yet to be translated into a noticeable pick up in capital goods orders or freight volumes for North American industrials. Equity valuations in most sub-sectors seem to reflect the optimistic view of acceleration in their respective end-markets, as well as the likelihood of U.S. corporate tax reform and fiscal stimulus spending adding to earnings growth for 2018. Therefore, we continue to favour companies with higher idiosyncratic opportunity. One of our preferred names at this point remains Waste Connections Inc., whose management team continues to deliver impeccable execution integrating the highly accretive Progressive Waste acquisition. Air Canada also remains a favourite name since we still believe the market has yet to fully price-in the sustainability of the airline’s full-cycle profitability, as well as its improving free cash flow generation profile.

MATERIALS

We remain neutral on the Materials sector, continuing to favour non-cyclical themes in Chemicals and Packaging. Zinc and Copper have seen inventories draw recently with greater scope for outperformance, while ferrous metals remain overhung by iron ore oversupply and reluctant buyers in developed markets. We continue to favour Trevali Mining Corporation given the multi-year low in Chinese zinc inventories coinciding with the company’s recent acquisition of high-quality producing zinc assets from Glencore PLC.

Recent resurgence in Precious Metals M&A highlights the scarcity value of successfully-ramped single-asset operators (such as Guyana Goldfields Inc.) in the face of depleted project pipelines among the majors. With industry titan Barrick Gold Corp. beset by recent geopolitical risk from Argentina and Tanzania, greater value is found in growthy mid-tier companies like B2Gold Corp and Endeavour Mining Corporation. With the reflation trade winding down, we will need further evidence of an industrial resurgence to justify greater cyclicality.

SECTOR OUTLOOKS


HEALTH CARE

With the ongoing policy uncertainty in Washington, Health Care sector performance continues to be choppy. The House of Representatives passed the American Health Care Act (AHCA) to repeal and replace “Obamacare” in May, but the Senate decided they would write their own bill. At present, the GOP does not appear to have the votes to pass the bill, but they are still hoping to hold a vote prior to the July 4th recess. For now, Obamacare remains the law of the land, but the uncertainty (including cost sharing reduction payments to health plans) has contributed to a decline in enrollment and some managed care companies are exiting the individual insurance market.

Sub-sectors that are directly impacted by changes to Obamacare include hospitals, Medicaid-managed care companies, and supply companies that sell into the hospital market place. Pricing risk fears appear to be abating despite continued rhetoric by politicians. Although price control is becoming a bipartisan issue, legislative change is going to be tough (the industry-friendly Republican-controlled Congress supports a favorable regulatory and reimbursement environment) and Congress’s appetite to talk health care after passing AHCA will be low. Congress may look to the new, non-traditional U.S. Food and Drug Administration commissioner, Scott Gottleib, for innovative approaches to control drug prices. There is also a possibility that the Trump administration could sign an executive order aimed at lowering drug prices.

On a positive note, tax reform will be front and center after AHCA is passed. Lowering corporate tax rates will benefit Health Care companies with US-facing end-markets (eg managed care organizations, facilities, smaller biopharma and device companies) while repatriation will help the larger multinationals (large cap biopharma and device companies). If AHCA is signed into law before Congress’s August recess, it will be a positive catalyst for the sector (we would expect rotation into the biopharma sector from safe-havens like medical devices and tools).

STAPLES

Staples continued to outperform through Q2, a trend that began towards the end of last quarter. This outperformance was starker in the Canadian market given the rotation out of the Energy sector, which typically benefits Staples. However, fundamentals in both markets have been extremely challenging.

In the U.S., increased competition from Amazon.com, Inc. (Amazon), Aldi Einkauf GmbH & Co. oHG, and Lidl Stiftung & Co. KG have put pricing pressure on fast-moving consumer goods and driven an increased push towards private label brands. This challenging retail environment is putting significant pressure on consumer packaged goods companies. Canadian retailers are still experiencing commodity-driven deflation, but are also experiencing increased competition from Costco Wholesale

Corporation, Wal-mart Stores, Inc., and Amazon (to a lesser extent). Costco in particular is making a material push into the Canadian market, accelerating their store growth from a couple of stores per year to eight in 2017.

We have recently added Empire Company Limited, where self-help can offset challenging industry fundamentals.

TECHNOLOGY

The MSCI and Canadian technology indices have generated 19% and 10% year-to-date returns, respectively. The demand environment has seen broad-based strength, with enterprises accelerating their adoption of digital technologies; internet titans investing aggressively to support their cloud ambitions; and the semiconductor industry hitting 21% YoY revenue growth rates — levels only seen on three fleeting occasions over the past twenty years. With this favorable backdrop, low interest rates, a weak USD, and deteriorating fundamentals in other major sectors, the Technology sector benefitted from investor fund flows. We now see Tech positioning as crowded, particularly among growth-focused stocks.

The Technology sector may be susceptible to a near-term pull-back, particularly should fund flows rotate towards value and cyclical market sub-sectors. As such, we have reduced some of our overweight positioning in the group. In Canada, we like CGI Group Inc. The company has seen a return to organic revenue growth in recent quarters. We like the product and customer focus that George Schindler has established since the start of his CEO tenure in October 2016. Internationally, we like Nuance Communications Inc. a leader in speech recognition and transcription software and services. We see the stock as a thematic play on artificial intelligence adoption at an undemanding valuation of 14x P/E. Organic revenue trends turned positive in the March 2017 quarter with tailwinds in multiple areas, including health care, automotive and contact centers.

FINANCIALS

The Financials sector has been quite volatile following the post-U.S. election rally: the yield curve has flattened and the euphoric sentiment around Trump’s pro-growth policies has cooled. Notwithstanding this cooling sentiment, we believe the banking sector has reached an inflection point in which profitability is set to improve and capital return will ratchet higher as the decade-long headwinds—brought on by low rates, increased liquidity, de-leveraging and elevated regulatory spend—are set to become tailwinds, particularly in the U.S.

We are more cautious on the outlook for Canadian Financials given the recent liquidity issues experienced in the alternative mortgage space as well as early signs of cooling in the Greater Toronto Area housing market. It is too early to fully assess repercussions from the recent mortgage

SECTOR OUTLOOKS


rule changes in the GTA and the liquidity squeeze felt across the Alt-A space: we prefer to see this play out before becoming more bullish on depressed valuations. In our base case, we continue to expect credit trends to remain benign and the loan growth picture to moderate, but believe downside risk is elevated. We favour banks with strong core deposit franchises, domestic scale, and a proven ability to drive efficiencies. Additionally, as the economic outlook continues to improve in the U.S., and the capital markets environment remains healthy, we like banks with leverage to improved U.S. growth, higher rates and market- sensitive revenue streams. Our favourite name in the space is the Royal Bank of Canada.

We are becoming more constructive on select names in the life insurance space. The macro backdrop has improved and valuations are attractive in the context of higher long-term rates in both Canada and the U.S. We prefer lifecos with room for ROE expansion and leverage to growth outside the Canadian market. Our preferred Canadian lifeco is Manulife Financial Corporation.

In the asset management space, we prefer alternative asset managers like Brookfield Asset Management, Inc. to traditional asset managers, given the secular trends of stringent regulation and ongoing fee pressures faced by the latter.

ENERGY

Despite an extension to the existing OPEC agreement to Q1/2018 and the beginning of potentially substantial crude inventory draws in the U.S., the energy index once again underperformed the TSX by a wide margin in Q2/2017.

The bear case for Energy is now well articulated in the market, pointing to 2018 oversupply driven by U.S. shale oil growth and the ultimate exit from the OPEC supply agreement in Q1/18. The more entrenched view is that the perpetual cycle of cost improvements underway in the North American onshore, coupled with deflationary pressures elsewhere (offshore) and status quo demand growth, means sub-$50/bbl oil prices and elusive returns for most energy industry participants. Against this backdrop, investor focus has now converged on the downside risks to aggressive short-term (2017/18) production targets (or upside to capex budgets) for oil producers, particularly with WTI sub-$50/bbl.

With energy stocks down 20%+ YTD, crude inventories starting to draw, and the market again in rationing mode (for U.S. shale), we are looking for the re-set of 2018+ production growth expectations to put a floor under the equities. We are positioned to come out of this pullback owning the highest quality end of the spectrum such as Canadian Natural Resources Ltd., Seven Generations Energy Ltd. and ARC Resources Ltd.

UTILITIES

The Utilities sub-sector had another exceptional quarter, up over 6%, buoyed by investor thirst for yield in the wake of falling long term interest rates. Due to subdued earnings growth and record-high valuations in the space, we remain underweight the sector both in Canada and globally. We are least constructive on regulated utilities, especially those with low growth and concentrated jurisdiction risk. The sub-sector looks especially weak when compared to traditional energy infrastructure companies, as the latter offer better yield, better relative valuations, better cyclical upside, and improving regulatory risk.

REITs

The REIT complex has been a major beneficiary of low rates, which have allowed REITs to acquire and re-finance at attractive debt costs. We believe the days of high growth are behind them (same-store sales growth and FFO growth have been on a decline since peaking at 11% in Q4/11).

At this stage in the growth cycle, our preference is to own names that have secular growth drivers, like Chartwell Retirement Residences (Chartwell). Chartwell is the largest operator of retirement homes in Canada. We believe the company has significant growth opportunities (both organic and inorganic) and expect Chartwell to increase the gap with the rest of the competition (in terms of cost efficiency) as it grows in scale. Finally, institutional capital favours retirement homes as an asset class: we would not be surprised should Chartwell get taken out one day.

TELCO

There is no change to our overall Telco thesis. We remain underweight the group (given valuations and subdued profit growth) and retain our preference for cable over telcos: cable enjoys a significant speed advantage over telcos. Rogers Communications Inc. remains our top pick owing to its potential for acceleration in profitability, the upcoming launch of X1 (which is a proven success in regard to reducing churn), and the proven reputation of Joe Natale as an excellent operator (we believe there are costs that can be taken out of the business).

SECTOR OUTLOOKS

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PMAM-OUT-Q2-2017

This report is published by Picton Mahoney Asset Management (PMAM) on July 7, 2017 and is intended primarily for institutional investors. It is provided as a general source of information and should not be considered personal investment advice or an offer or solicitation to buy or sell securities. The information contained in this report has been obtained from sources believed reliable; however, the accuracy and/or completeness of the information is not guaranteed by PMAM, nor does PMAM assume any responsibility or liability whatsoever. All opinions expressed are subject to change without notification. PMAM funds may currently hold long and/or short positions in the securities of the companies mentioned in this report.

FEELING REFRESHED? - Picton Mahoney€¦ · summer, and then resume an upward trajectory in the...

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