In many previous articles I have written about the importance of investor mood in evaluating long-term trends in the financial markets. Investor mood is always pessimistic and negative at market bottoms, and always optimistic and positive at market tops. This fact, known as The Theory of Contrary Opinion, is the underlying truth of the stock market.
The recent U.S. presidential election seems to have thrown a monkey wrench into the mood of the general population. Are American investors as skeptical about their economic future as Mr. Trump's critics are about their political future?
In Canada, we receive a constant stream of pessimism about Mr. Trump. But the fact is that it has been only three months since he won the election. And all he has done so far is implement a few of his election promises. This really shouldn't surprise anyone. Before the November election, the press condemned him as a racist, fascist, corrupt, power-mad, twenty-first century Hitler. But he won the election anyway. Nothing has really changed in the past few months. As investors we must try to understand if the American investing public is really pessimistic and negative, or if are we merely reading a barrage of Democratic commentary. Or, is the average American investor as ticked off as the average Democratic news commentator?
Since the November election, the stock market has registered another all-time high. The U.S. dollar touched a new, recovery high. Leading economic indicators point to a healthier economy. If these economic facts are being accompanied by a general mood of investor pessimism, then the bull market is ON, meaning that my recent caution regarding the stock market is actually over-caution. If the barrage of anti-Trump rhetoric is merely poor-loser Democrats bemoaning their defeat, then investor caution is warranted. If the whole American population is worried, not just Democrats, then the stock market has been 'climbing a wall of worry'. It would be time to be fully invested again.
Making these observations is particularly difficult in Canada, because our news is reported with a serious anti-Republican bias. The Canadian press loves to bash Mr. Trump. They will report every blunder he makes, and not report any positive, constructive action he might take. With such imbalanced news reporting, how can we judge the general mood of American investors? How can we judge when it's time to buy or sell?
In my stock market book, Beyond the Bull, I suggest that investors train their minds to be objective. The rhetoric around Donald Trump demonstrates how difficult this can be. How can Canadians remain objective as long as our American neighbours continue their negative flood of political gloom and doom?
For the answer to this important question, I refer to Detective Sergeant Joe Friday, of the old television show, Dragnet. Confronted with a hysterical witness to a crime, Friday is famously remembered for saying: "Just the facts, Ma'am." [True, but to tell the whole truth, the phrase was never uttered in Dragnet. It was popularized by comedian Stan Freberg in Dragnet parodies such as St. George and the Dragonet.]
So, let's review "just the facts" as we try to assess today's financial trends and try to decide how to position our investment portfolios.
The U.S. stock market registered a new high in February 2017. It remains in an up-trend that began almost eight years ago, in March 2009. (The Canadian stock market average has not yet exceeded its September 2014 high. It is very close: the TSX Composite may have registered a new high by the time you read this.)
Long-term interest rates, as measured by the yield of 20-year+ U.S. Treasury bonds, registered their lowest levels in July 2016. Since then, long-term interest rates have risen, indicating a possible bottom was reached last summer. This "down-to-up" trend reversal will be confirmed if the exchange traded fund iShares Barclays 20+ Year U.S. Treasury Bond ETF (NASDAQ-TLT) drops below 114. TLT is currently around 120. It was 143 when the reversal occurred last July.
The Canadian bond market tracks its U.S. counterpart; Canadian long-term interest rates may also be in an up trend. By following iShares Core Canadian Long Term Bond Index ETF (TSX-XLB), the Canadian exchange traded fund reflecting long-term bond prices, you can monitor the trend. If XLB drops to or below 22.50, the down-to-up trend reversal will be confirmed.
Since the banking crisis of 2008, both Canadian and U.S. central banks have been keeping short-term interest rates low in hopes that a low level of inflation would return. This intention is the bullish economic backdrop for both the Canadian and U.S. bond markets, and the U.S. stock market. The bearish backdrop for the Canadian stock market is the deflation of energy, metals and materials prices these past 4-1/2 years.
The U.S. dollar, as measured against a basket of non-U.S. currencies, has touched a new recovery high since the U.S. presidential election. Since the New Year, it has declined again.
The up trend that began in the summer of 2014 appears to have been re-kindled.
The Canadian dollar, as measured by the U.S. dollar, was in a downtrend from 2011 until January 2016. Because the Loonie is considered a petro-currency, I will review its trend and the trend of oil prices together.
The price of oil dropped sharply from June 2014 to February 2016. It then rallied sharply from about $26 U.S. a barrel to around $51.00. This was followed by a decline to below $40.00. In previous articles, I had judged that this decline was not a sufficient 'test' of the previous lows, and held that the down trend was still in effect. Since Mr. Trump's election, oil prices touched a new recovery high. For this reason, I am changing my position: The down-to-up trend reversal in energy prices occurred one year ago, in February 2016. Later in this article, I will suggest certain energy stocks for those interested in short term trading.
How does this economic-trend realization affect investment strategy regarding the Canadian dollar (CAD)? If the Loonie remains a petro-currency, then the January 2016 low of just under 68 cents U.S. was THE low for this cycle. Last year, CAD rallied sharply from 68 cents to about 79 cents U.S. in May. Since then, it has been drifting sideways; it did not touch a new high late last year as did oil. CAD is weaker than oil. It appears that CAD is no longer as sensitive to the price of oil. Other economic factors, like comparative interest rates and the balance of trade, will start to influence the Loonie as much as oil prices.
In summary, energy prices are in an up trend and the CAD is in a trendless sideways drift.
Speculators can participate in energy's up trend by trading the following oil and gas stocks:
Inter-listed: Baytex Energy Corp. (TSX-BTE; NYSE-BTE), Penn West Exploration Ltd. (TSX-PWT; NYSE-PWE) and Vermilion Energy Inc. (TSX-VET; NYSE-VET);
U.S. listed: Chesapeake Energy Corporation (NYSE-CHK), Marathon Oil Corporation (NYSE-MRO) and Cabot Oil and Gas Corporation (NYSE-COG); and
TSX listed: iShares S&P TSX Capped Energy Index Fund (TSX-XEG).
The long-term price of gold is in an up trend that began at $1,046 USD per ounce in December 2015. It rallied to $1,377 in the summer of 2016 and corrected to $1,127 in December of that year. So far in 2017, it has been rising. Both investors and traders can participate in this uptrend now with precious metals mutual funds and gold mining stocks.
Because of the long duration (2009 until now) of the up-trend in the stock market, it is more prudent to look for a top than to expect the up-trend to continue. The key factor is investor mood. Stock markets continue to rise when investors continue to be pessimistic. When that healthy skepticism turns to optimism, the bull market ends. That's why it's important for us to remain objective about the current U.S. news environment.
Is the USA really as ill as Mr. Trump AND the left-leaning American press say, or is all this current rhetoric merely election scare tactics and poor-loser syndrome by commentators who backed the wrong horse? If America's problems are real, the market is 'climbing a wall of worry' and we should become bullish. But if these problems are Trumped-up election promises and media sour grapes, investors might actually be over-optimistic; we should remain cautious about a stock market top.
My struggle is to remain objective during the word war being waged by the U.S. media and their new president. As an investment advisor, my value lies in my impartiality. In my 40-year+ investment career, it has never been more difficult to stay out of the emotional arguments. Too bad. The intense emotion being expressed by both sides is the real danger.
This is an edited version of an article that was originally published for subscribers in the February 2017/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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