Brent CookA Comment -- General Comments From an ExpertA CommentaryCOMMENTMar 06, 2018

The U.S. banks report tomorrow. He expects earnings to be the same as Q1's. Unless something bad happened in the economy in Q1, then the earnings follow trend. Overall, the US economy is strong with AI spending while poorer Americans have seen wage gains. Expectations are high though. If the oil price spikes again, it won't effect US companies that much, because the US market is largely tech driven. US small caps have seen a huge rally as money flows out of semis. We might be in an extended cycle for semis.

What's in the rearview mirror and what we expect going forward are two different things. Numbers are expected to be excellent. We've seen a broad-based lift in earnings across many sectors. Question is, can it continue? 

If nominal GDP is firing, earnings are really good. When the economy grows, so do revenues.

Anything they have to say regarding sensitivity to the consumer, such as credit card delinquencies, will be important. Loan losses are something we have to think about. Doesn't think the huge stress on the consumer from inflation is behind us. As we get into midterm elections that's what matters to voters, though it may not matter to where the S&P 500 goes from here.

The headlines are groceries and gas pumps because that's what touches the average person every day. We have to look deeper than that. When earnings are being reported, what are they saying about cost pass-throughs? If it's airlines, higher fuel costs will show up in ticket prices. In terms of banks, it's really on credit card sensitivity and spending patterns.

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Tailwinds from it will shape economies around the world for decades. An exciting story, but creating day-to-day volatility in the markets to a degree that makes no sense. We've entered a very speculative phase of the market. Volatility is being exacerbated by "pods" and day traders using leverage.

Inflation announcements will be less important than renegotiating CUSMA. In the short run, that'll be more important than fluctuations in short-term interest rates.

The US has said that if they get another sharp inflation number, there's a good argument to be made for the Fed to raise rates at the next meeting. He doesn't think the BOC should raise rates, based on the Canadian economy. If the US raises rates and Canada isn't, that tells you right there which direction risk is on the CAD.

In creating structural plans, AI is a great tool but it's not going to be responsible for the whole project like a road. A lot of connections people are making now are just silly, but are ripping through the market.

There will definitely be an impact, but it's a question of magnitude. Level of volatility in markets tells us that uncertainty is high in both directions. We've seen a massive repricing in software names, but we're not going to see wholesale replacement. Meaningful changes to many businesses? Yes. Will it help some of them? Absolutely. Value to be had right now.

Commodities, Wages, and Inflation
The basic inputs to a lot of things we can drive inflation.  Looking at broad commodity indexes back to 1991, we see that most commodity prices actually have not grown after taking into account the cost of money. So how is this causing inflation? The six o'clock news keeps making that connection.

Most people think about the $$ they put in the gas tank and what they just spent at the grocery store. And they feel inflation.

The real inflation, though, that drives costs longer term comes from wages. It's the biggest cost of input to most industries. In the service economy of NA (70% services), wages matter a lot. Agricultural, corn, wheat prices have been pretty stable over history. Technology is creating a lot of disinflation, as costs are driven lower by technology doing the work of farm workers.

He brought along a chart of wages in the US. Note the bottoming in 2011. What happened then? The average baby boomer turned 65. The dynamics in the labor force is changing. More and more people are retiring, we have less immigration, and the average family is having less than 2 children. Demographics are bad for sources of labour. The future of supply/demand in the labour market is really going to tell us where inflation will be. The new base for inflation is unlikely to be 2%.

AI can be a big part of driving labour productivity. Can AI cut your grass? It actually can now! AI will take a lot of jobs, while others will be created. As we go through earnings season, he's looking for what companies tell us about wages.

It's been a big train wreck of a year with conflicts on and conflicts off. If peace breaks out, funds that flowed into energy will exit amid profit-taking and flow to other sectors of the economy.

The under-appreciated risks include potentially higher interest rates in the US. That would put the Canadian dollar under pressure. Will the BOC have to defend that? There's a limit to how far we can allow our dollar to fall.

There are some issues with regard to the US labour market. Starting to see a bit of weakness in job creation. Participation rate is down. Average growth in hourly wages is marginally in the black. That could be a harbinger. Usually when the labour market rolls over it tends to be a bad signal.

By and large, US market's going with the theme that AI's going to take over the world. There's a lot of opportunity now, especially with cash reserves that people have from taking profits.

We've had a sharp pullback in energy prices from the highs. That's positive for markets. Investors are starting to return their focus to corporate and economic fundamentals.

Certainly, a renewal of tensions is starting to worry the market a bit. But we know that as quickly as it can start, it can end quickly as well.

Stocks in the semiconductor and memory spaces are high beta. You're going to have major moves upwards, and then major pullbacks as investors take profits. There's a bit of fear currently in the marketplace.

Still sees the needs for data-centre capacity, with forecasts in the US quadrupling by 2030. Still sees major spending by the hyperscalers, so semiconductors and others will be major beneficiaries.

The AI story isn't over by any means, and it's not stalled. It's just normal profit-taking.

Looking back to 1950, on average we see about a 17.5% market drawdown in the year of a midterm election. In March, we had about a 9-10% drawdown. It could be that was it, or we could see a bit of renewed volatility going into the elections.

Because we've had such a great second quarter, it wouldn't surprise him if markets paused a bit.

Oil prices being much lower than where they were is important. Need to watch out for inflation and whether it remains sticky. Earnings are very strong, and that's helping markets quite a bit.

US cash on the sidelines is at record highs again. Some of that cash can rotate back into equities or other risk assets and help prop up markets again.

Oil prices being much lower than where they were is important. Need to watch out for inflation and whether it remains sticky. Earnings are very strong, and that's helping markets quite a bit.

US cash on the sidelines is at record highs again. Some of that cash can rotate back into equities or other risk assets and help prop up markets again.

Very tax efficient, as you're getting the dividend from the stocks plus the covered call premium overlay on top (typically a return of capital, so it's really a deferred capital gain). You can hold them within an RRSP or TFSA, but the tax efficiency obviously works well for non-registered accounts.

The question then becomes whether you should hold covered call strategies? The providers always highlight the tremendous yields. But when you start stacking them against the underlying securities, you're better off holding the underlying securities more often than not. As the options get struck, you miss out on the upside.

If you need income, and that's the most important thing for you, then covered call strategies can make sense. But don't get lured by the high, fantastic yield being promoted.

Absolutely. In fact, the inflationary concerns never really went away. 

The market was really pricing in an end to the conflict, but she's been more doubtful. Regardless what happens from a military standpoint, economic consequences outlast all of that. Bottom line is that she doesn't necessarily buy a ceasefire when you're dealing with several countries who aren't getting along.

Inflation is tricky because it takes a while for the effect of events to get priced in. We're dealing with higher energy prices, but there's a lag before it impacts food, airline prices, and such.

Another question is what effect will inflation have on interest rates? Prior to the conflict, the expectation was for cuts. That stopped. Now there's an expectation for possible increases. And that will affect the consumer. It's a snowball effect, which wasn't being priced into the market until a day like today.