Tuesday, August 5, 2014

Financial Comment - Correction coming?

Correction coming?
Last week, we wrote about the strength of the Canadian stock market and the fact that both Canadian and U.S. markets have been growing for more than 12 months without a major correction (more than 10%). Over the past several days, both markets, represented by the S&P/TSX Composite Index and the S&P 500 index respectively, have dropped by 2%-3%. 

This happened to be among the biggest 1-week declines in the past two years. And, apparently, the expectations of a long-overdue correction on both markets have played a significant role, especially on the background of such fundamental factors as the looming increase in bond yields in the U.S. once the Federal Reserve’s Quantitative Easing program comes to its expected end this autumn. Last week, the Fed already reduced its monthly asset purchases from $35 billion to $25 billion.

The softening of the U.S. job market is also cited as a contributor to the stock market decline: nonfarm payrolls growth dropped from 298,000 in June to 209,000 in July while analyst consensus was for a payrolls growth of 233,000. This raised the unemployment rate from 6.1% to 6.2%.  Although it appears that this level of unemployment isn’t so bad (in Canada the unemployment rate is above 7%), the labour force participation rate is a mere 63%, the lowest level since the late 1970s.  This weighs negatively on market expectations of future corporate revenue growth.

Another factor negatively impacting equity markets over the past week was Argentina’s default on $539 million in interest payments on sovereign debt which was due July 30. According to Bloomberg and Moody’s Investors Service, Argentina still has sufficient funds and the willingness to make the payment which is why its sovereign bonds are trading at a relatively high 80% of face value (as compared to 30% during the country’s 2001 default). But, apparently, equity markets were not impressed, and investors became less confident. Heading into a new week, most equity analysts remain bullish given continuing expectations of improving market fundamentals. At the same time, one cannot rule out the potential for a proper correction to occur during the remainder of the summer.

By: Ukrainian Credit Union Limited

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