Market, Report, and Portfolio Updates - September 15, 2022

Barkha Rani Sep 15, 2022
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Report Updates

We have posted report updates on Capital Power (CPX) and NFI Group (NFI). CPX is a power producer based in Noth American that is focused on growth and renewable energy. Shares of the company have done well over the past year as power prices increase, and management has noted some regulatory tailwinds. It has used derivatives to its advantage, and we think that this positions it well in the future. NFI is an EV bus manufacturer and offers EV charging infrastructure installation. It has seen some challenges in the conversion of its backlog, and there are a few noticeable areas for improvement on its balance sheet. We feel there are a lot of industry insights in both of these reports. 

Read the latest updates by logging in here!

Investor Sentiment Survey - RESULTS!

Thank you to all those that participated in this past market update's Investor Sentiment Survey. We have published the results from the survey in a report in the link below. Please note that the weightings and categorization of these results are still a work in progress, and the model(s) used to analyze the results may change over time as more data comes in. Overall, investors are feeling slightly more bearish than in the previous survey.

Survey Results - Aug 30

We look forward to releasing another round of the Investor Sentiment Survey at the next market update!

Market Update

The markets have witnessed volatility over the past couple of weeks as investors awaited Tuesday's US CPI print. Headline inflation missed forecasts but demonstrated an improvement against last month's number, however, core inflation rose against the prior month and this has created some turbulence in the markets. Oil prices have been showing weakness which initially eased investors' concerns, but the services sector continues to underpin the elevated inflation numbers. Bond yields are rising and the consensus is for the Federal Reserve to hike rates by 75 bps at its meeting next week. Still, markets have not made new lows and headline inflation is not accelerating, so we feel it is necessary to assess how the contracting economy interplays with the financial markets.  
A Disconnect between the Markets and the Economy
As most of us have heard before, the financial markets are forward-looking. One of the biggest hurdles for investors is trying to understand when periods of disconnect between the markets and the underlying economy occur. Take 2020 for instance, the financial markets declined roughly 30%, and yet we were just at the precipice of the economy locking down for an indefinite number of months, which would lead to massive losses in corporate profits. When the markets rebounded in the following months, many investors were left scratching their heads as to how the markets could be increasing in the face of a worsening economy. The biggest takeaway from this period in time was that the markets were forward-looking and pricing in the impacts of QE, fiscal stimulus, interest rate declines, and the ingenuity of consumers to shift their spending to online.

Looking at the Business Cycle through PMI Readings
We find that the Purchasing Managers’ Index (PMI) is the best indicator of the business cycle. The PMI is a survey sent to senior executives across several hundred companies in different industries within the manufacturing sector. The index aims to identify whether the economy is expanding or contracting through the lens of purchase orders. The index is a range between 0 and 100, and a reading above 50 indicates that new orders are expanding relative to the previous month. A reading of 50 indicates that orders are flat against the prior month, and below 50 represents a contraction in new orders. An expansion/contraction in purchasing orders means that the economy is also likely to expand/contract, as these are orders from consumers. Since it is a survey from senior executives that make purchases monthly, it is known to be a leading economic indicator.
When the PMI survey results are viewed on a month-over-month basis, they can demonstrate a lot of volatility, however, when placed on a one-year moving average, the overall trend of business activity becomes clearer. In the charts below, we have compared the PMI results (on a one-year moving average) to the one-year percentage changes in the TSX and S&P 500 prices and forward earnings. One thing to keep in mind is that since the PMI numbers are on a one-year moving average (average readings over the past 12 months), their trend will lag the actual readings by a bit.

The first chart is the Canadian PMI numbers compared against the change in the TSX forward earnings. We can see a strong correlation between the two over the past 20 years, as expanding/contracting purchasing orders move in tandem with corporate profits. Not only is there a strong correlation between the two, but we also realize that the ebb and flow of the PMI readings are representative of the business cycle. The PMI figures demonstrate that we are in the early stages of the business cycle contracting. Given this, we would not be surprised to see the percentage change in forward earning estimates continue to decline in the coming year(s).


The below chart looks at the same PMI figure as above but compares it to the one-year percentage change in the TSX. Here we can see that the markets have fully rolled over and have effectively priced in a large move down in the business cycle. Markets are forward-looking, and so this lead time in the TSX pricing in a sharp move down in both earnings and economic activity is logical.


We have run the same exercises as above but for the US markets. We can see an even stronger trend over the past three decades with the US PMI readings and forward earnings estimates. Earnings have begun their descent against last year and are not far off from a historical place of support.


Again, below is a very similar-looking chart to the Canadian markets but for the US markets, where the S&P 500 has effectively priced in a decline in the business cycle. The one-year percentage change in the S&P 500 has already moved to a level that is in line with previous levels of support. Here we can fully see the large disconnect between markets and the business cycle, where markets have priced in the trough of a business cycle and the actual business cycle is in the midst of a contraction.


Key Takeaways
In today’s financial market, it feels as though there are too many economic headwinds to keep track of, and investors and non-investors are all well aware of the pending and actual economic woes. We believe that the business cycle is currently contracting and so are forward earnings. Going forward we expect to see continued weak PMI readings, thereby driving the PMI moving average lower. Although, the most critical takeaway is that from the charts above we can see a wide disconnect between markets and PMI readings, indicating that markets have already priced in both a decline in the business cycle and lower corporate earnings. We believe that the economic challenges that many are aware of have effectively been priced in by the markets and that it is possible to begin to see a new divergence between markets and the economy, where the economy continues to worsen and markets begin to improve, proving out their forward-looking nature.


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