Perhaps my recent fondness for watching the new Star Trek series (filmed in Toronto, no less) is influencing my choice of words this week, but I find that the resurgence of a risk-on tone in the market does feel like we have been “transported” to a different world than we found ourselves on just two weeks ago.  Since the dismal U.S. jobs report at the start of the month, a procession of indicators has pushed back against the narrative that the U.S. economy is in the throes of a recession and this has factored into not only equities, but commodities as well.

 

What do we typically think of when someone says “recession”?  For one, we would imagine a growing line outside of the unemployment office and shrinking one in front of our favourite store. Neither seems to be happening today.  Initial jobless claims fell last week by 7,000 to 227,000. Expectations were for a modest gain to 235,000 and not only was this the second straight week where new unemployment claims applications fell, but the cumulative decline has erased the increases in July that took claims to an 11-month high of 249,000. 

 

 

As much as the July performance coincided nicely with that month’s dismal payrolls data, thus stoking recession embers, the reality is that jobless claims from the beginning of 2022 to the present has been more white noise than an indication of labour despair. When a recession is truly underway, claims take a definitive track higher alongside an upward trend in the unemployment rate.  As I discussed last week, the move in the U.S. unemployment rate above 4% has masked the influence of a growing labour force from increased inflows of new Americans.  Firms have indeed slowed down hiring and some (mainly in the technology segment) have cut staff, but this isn’t the wholesale payroll reduction that we are used to when the economy shrinks.

 

This also explains why the largest sector of economic demand - consumer spending - hasn’t fallen flat on its face either. It has been two plus years since the Federal Reserve began hiking interest rates aggressively. There has been a slowing in spending growth as consumers re-allocated saving towards debt repayment and meeting the sharp increase in the prices of goods and services (specifically rent). This should have caused severe restraint on the pocketbook, but not enough to make a recessionary dent in the overall pace of expenditures.

 

 

This week’s July retail sales report was yet further evidence of just how resilient that pocketbook is. As the above chart shows, total sales jumped 1% to almost $710 billion in July after a 0.2% dip in June (the previous report showed sales as flat). Left unattended, that decline could have led to an actual contraction in consumer spending in the third quarter. Instead, barring a major setback in August and September, the quarter looks safe. More importantly, the so-called control group (excluding motor vehicle sales, gasoline stations, building materials and food) increased by 0.3% in July after a 0.9% gain in June. 

 

If we aren’t losing the consumer, then overall economic growth for the remainder of 2024 should remain sound. And if that’s the case, we have one of two supportive factors for the energy patch. As the chart below shows, WTI crude futures had recovered from a low just under $73/barrel in early June to almost $84 a month later. The optimism faded as the July woes set in and crude prices came within a nickel of breaking the closing low in April and potentially establishing a new low for the year (on January 2nd, futures closed at $70.50).

 

 

Since the Fed started tightening policy, oil prices have been on a rollercoaster ride, which was to be expected. Yet, the range has been relatively narrow considering the magnitude of rate hikes. During this period, we haven’t seen WTI futures touch $65, and we haven’t seen a return to levels of $95, though we came close in 2023. The fact that the $72 level has held this summer suggests that market participants are factoring a less restrictive policy stance by the Fed, at a time when the economy really isn’t in terrible shape to begin with.

 

The other factor is geopolitical. With tensions still high in the Middle East, a risk premium remains embedded in the price of crude, and it is reasonable to assume it will stay there at least until the U.S. election. The offset is that OPEC+ plans to increase output in the coming months, but even here there is an implicit message. If economic conditions were so sour, or anticipated to be so, then it wouldn’t make sense to boost production and create a potentially large excess supply situation.

 

 

The pessimistic tone in oil prices has been reflected in stock prices. The MSCI World Energy Index has struggled since April to resume the rally that we saw in the first quarter. In our opinion, a return to the $80 region for crude should allow global energy company valuations to improve, including Canadian and U.S. names. In fact, Canadian energy stocks have outperformed in recent weeks and are close to re-testing the highs from June and July of 2022, as seen in the chart above.

 

 

We expect that companies outside of Canada will close the performance gap towards year-end, especially south of the border. The S&P500 energy sub-group is trading well back from its levels at the start of the year and once we see interest rates heading on a downward path, this should create the conditions for demand improvement as I discussed earlier, and an opportunity to increase exposure in the U.S. patch. Again, in line with our overall U.S. strategy, we want to stick with larger cap names, with strong balance sheets and free cash flow. On top of that, we still focus on hedging out currency risk while the Canadian dollar hovers near these relatively low levels.

 

There are a number of themes that are threading their way into the final months of the U.S. election, from a shift towards quality and value to re-allocating excess cash into fixed income. This is going to be an environment where sector and stock selection becomes even more important and from where we sit, some might be more energized than others.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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