The US Fed(eral Reserve Bank) is talking about raising interest rates. Normally, that would cause bond yields to rise and bond values to fall. But bonds continue to perform reasonably, and with stocks taking a breather, bonds appear to be keeping up. In the past, I’ve never had a chance to see a graphical representation of a yield curve, so I didn’t have a concept of what a “normal” yield curve looked like. It’s usually expected to be convex, where T-bills have low yields, short bonds are quite a bit higher, medium bonds are a little higher yet, and long bonds are slightly higher than that. Ever since I’ve been creating a graphical representation of the yield curve (see below), it’s been concave. Last week, I rewrote the algorithm that produces it, in order to increase the number of data points, with the expectation that it would change the shape. The good news is that what I created previously was not misleading. The bad news is that I don’t know yet what a concave yield curve means, other than the fact that rates are really low.

I will also point out that I added a calculation for the current risk premium of equities, both large cap and small cap Canadian stocks. I did this by finding the earning yield (inverse P/E) and subtracting the long bond yield. What is surprising, currently, is that the risk premium for small caps, which should be larger, is actually quite a bit smaller. Therefore, small caps appear overpriced and unlikely to provide enough (excess) return to compensate for the risk.

Interest Rates

yieldcurve

The 3 month T-bill rate is 0.46%, the 1 year T-bill rate is 0.55%, the 3 year government bond yield is 0.65%, the 10 year government bond yield is 1.35% and the long government bond yield is 1.99%. The yield curve is normal. Long government bonds appear very overvalued. There seems to be very little opportunity for profit in bonds. A safe haven, such as tangible assets (eg. precious metals, real estate, etc.), may be a better bet.The equity risk premium for large caps, in Canada, currently appears to be 3.02%. For small caps, it currently appears to be 1.41%.

Credit Environment

Corporate bonds are performing better than government bonds, long bonds are doing better than short bonds and, in the third dial, high quality is doing slightly better than high yield.
guage1guage2guage3

Currency

The Brazilian Real (BZF), and Japanese Yen (FXY) are the only currencies outperforming the US dollar, which has been rising for the past couple weeks.
The Canadian dollar has been losing value compared to the US dollar.

Equities

Where does there appear to be more opportunity right now? Stocks are taking a break and doing barely better than bonds.
US bonds vs. US stocks:
guage4
Canadian bonds vs. Canadian stocks:
guage5

Global Markets

Comparing national stock markets, Peru (EPU), Philippines (EPHE), New Zealand (ENZL), Denmark (EDEN), and Belgium (EWK) are rising, while other regions appear to be neutral or falling.

US Stocks

Yesterday’s closing price was 2,048.04. This is 0.04% higher than last week’s price (2,047.21), and -1.90% lower than last month’s price (2,087.79), and 6.13% higher than the price three months ago (1,929.80), and -1.60% lower than the price six months ago (2,081.24), and -2.54% lower than the price one year ago (2,101.49).The average P/E ratio of the S&P 100 (equal weighted) is 22.00. This implies the market is overvalued. There is likely an overly optimistic outlook and risks may be unduly discounted. This implies a forward capital return of 4.54% (before dividends).

The following stocks appear to present short-term (2-6 months) opportunities for price increase (buy high, sell higher):

  • California Resources Corporation (CRC)
  • Monsanto Company (MON)
  • Amazon.com, Inc. (AMZN)
  • Devon Energy Corporation (DVN)

These stocks appear to be priced attractively from a long-term (3-5 years) perspective (buy low, sell high):

  • General Motors Company (GM)
  • Ford Motor Company (F)
  • Metlife, Inc. (MET)
  • Conocophillips (COP)

Canadian Stocks

Yesterday’s closing price was 13,919.60. This is 0.19% higher than last week’s price (13,893.50), and 0.33% higher than last month’s price (13,874.00), and 9.06% higher than the price three months ago (12,763.40), and 3.31% higher than the price six months ago (13,473.80), and -6.88% lower than the price one year ago (14,947.50).The average P/E ratio of the TSX60 (equal weighted) is 22.88. This implies the market is overvalued. There is likely an overly optimistic outlook and risks may be unduly discounted. This implies a forward capital return of 4.37% (before dividends).

The following stocks appear to present short-term (2-6 months) opportunities for price increase (buy high, sell higher):

These stocks appear to be priced attractively from a long-term (3-5 years) perspective (buy low, sell high):

  • Power Corporation Of Canada (POW.to)
  • National Bank Of Canada (NA.to)
  • Bank Of Nova Scotia (BNS.to)

Other Assets

Crude Oil (HUC.to),TSX REIT (XRE.to), Global Infrastructure (ZGI.to), Gold (IGT.to), Canadian TSX (ZCN.to), Canadian Universe Bond (XBB.to), US S&P 500 (SPY), Silver (HUZ.to), World stocks (VDU.to) are performing better than cash.
The gold price is rising, which often indicates nervousness in equity markets.
The oil price is rising, which increases manufacturing input costs and energy costs and may slow economic expansion.

Portfolio

A theoretical portfolio, split evenly between gold (IGT in Cdn$), real estate (XRE in Cdn$), Canadian stocks (XIU in Cdn$), US stocks (XSP hedged to Cdn$), international stocks (VDU in Cdn$) and bonds (XBB in Cdn$).

As of today, the theoretical portfolio would hold:

  • One unit (20%) of gold
  • One unit (20%) real estate
  • One unit (20%) Canadian stocks
  • 2 units (40%) bonds
Market Outlook, May 24, 2016

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