Ignore unprepared Poloz; flying Financials are a strong bullish signal for the Canadian economy and stocks

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As we put together our weekly Monday market comments for INK subscribers, we are focusing on the Financials which have been ripping higher over the past month. The S&P/TSX Financials Index is up 6.5% over the past 30 days. It is often said that a sustainable market rally is not possible without the participation of the Financials, so seeing the group leading the overall market is an encourage sign. The positive price action is supported by our INK Financials Indicator which is signalling that the stocks in the sector put in a significant low in August.


Indeed, the Shares S&P/TSX Cap Financials Index Fund (XFN) crossed its 200-day moving average last week. While some retesting of the move cannot be ruled out, particularly as the ETF is showing some signs of being overbought, the trend is encouraging.

Last Monday we saw the election of a new government that has promised to revise the tax code and boost infrastructure spending by going into deficit. In our view, this should have a net positive impact on growth and sentiment over the next few years. That should help both the loonie and Canadian stocks. Working against this positive dynamic was a downbeat monetary policy report issued on Wednesday by the Bank of Canada.

We would ignore this report as even the central bank governor himself has admitted that its forecasts involved significant uncertainty. Remarkably, the central bank seemed unprepared for the prospect of a change in fiscal priorities by a new government. In his mid-week press conference, Mr. Poloz had nothing to offer on the prospect of either increased fiscal spending on infrastructure or a change in tax rates as proposed by the incoming government. This is unusual. We would have expected the central bank to be fully prepared for any outcome on Monday night. Stephen Poloz has never been shy in offering us his highly confident views on the economy. Why so equivocal all of the sudden?

Moreover, the central bank is now trotting out a new measure of "underlying inflation" which fits better with its anti-loonie narrative. This new measure, which does not form the basis of the central bank's mandate, seeks to strip out the "temporary" effects of currency depreciation. This is a ridiculous approach given that the currency has been in permanent free fall ever since Poloz took over from Mark Carney. We would note that the loonie began its descent even as oil was trading at the top of its range. Given that we still have to endure another 5 years of Mr. Poloz at the helm of the central bank, it is a stretch for the Bank of Canada to argue that the impact of a floundering currency will be temporary, especially since it has signalled that it wants the loonie to keep falling to help its preferred industries (currency-dependent exporters and residential real estate). As such, we dismiss the entire Monetary Report as lacking credibility. 

That said, continued Poloz dovish talk cannot be ignored as it is clear that his war on the Canadian dollar is continuing. Over the next few months, foreign exchange markets will have to contend with our mercantilist central bank governor's ongoing efforts to support his favoured areas of the economy (and damage those he does not favour, including non-currency dependent exporters) over the broad positive economic impacts that could unfold under the growth-oriented policies of the new government. In terms of which force dominates, a lot will depend on who becomes the next Finance Minister. Should he or she back the central bank's interventionist approach, the loonie is likely to head lower. The best signal for Canada would be for the new Finance minister to adopt a pro-market stance towards the loonie and remind Mr. Poloz that his job is to focus on mandated inflation targets rather than industrial policy or political outcomes.

Returning to the stock market, insiders remain upbeat. We note that the mid-cap oriented INK Canadian (CIN) Insider Index ticked into positive territory for the year on Friday. However, the resource and Valeant Pharma (INK Edge outlook: cloudy; VRX) heavy S&P/TSX Composite Index remains down 4.6% YTD. Nicholas Winton will be updating the technical outlook for the INK CIN Index early Monday

The latest and past editions of the Market INK report can be purchased in PDF format here.


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