It’s an oft-quoted curse: May you live in interesting times. While the Canadian equity market seems far from cursed lately, it is going through “interesting times”—and the curse could be just around the corner.
“In normal times investors overreact to bad news more than they react to good news. In today’s environment, good news has the upper hand,” says Benjamin Tal, deputy chief economist at CIBC. “Negative news is often ignored or creatively interpreted as good news.”
He points to a 9% rise in the Canadian stock market over the past three months—a quarter with more bad domestic news than good.
One example is that the Canadian manufacturing sector continues to struggle in the face of a soaring loonie. The sector represents just 12% of the Canadian economy today, compared to 19% in 2000.
It’s not simply a case of production being outsourced to emerging markets—American manufacturing is enjoying a renaissance.
And that’s where investors seem to be firmly focused: on the improving economic picture in the U.S.
The S&P 500 has rallied 12% since mid-December, largely due to improving economic data, but at the same time, investors have been discounting bad economic data.
During that time, one third of all major economic data released offered a surprise to the upside, which boosted stocks. But in the same period, 20% of the data released fell short of expectations—yet still resulted in an average daily gain of 0.13% on the S&P 500.
“How long this win-win trading environment will last is anybody’s guess, but the likelihood is that this process has not been exhausted yet,” Tal says. “The euphoric trading could continue until the market wakes up to the realization that whatever it gets now will be taken away by the big fiscal drag of 2013.”
Any sign of weakness in the U.S. economy is seen as a sign that the Fed will have to extend its “free money” campaign even further.
Tal points out that it’s hard for investors to avoid risk assets when the Federal Reserve has committed to holding interest rates at rock-bottom lows until 2014.
“This asymmetrical trading is due largely to the current asymmetrical Fed policy,” he says. “The market can enjoy the full benefit of stronger-than-expected macro data without worrying about the usual spoiler of increased policy-tightening expectations.”