Something strange was happening with Canada’s stock market last week. Commodity prices soared as usual; copper, zinc and nickel reached brand new highs; while oil flipped back well over the $70.00 mark. Yet, the S&P/TSX Composite performed an elegant, yet uninspiring, death spiral.
There are very few certainties when it comes to investing, and one of them is that when commodity prices rise, Canada’s stock market follows suit. Instead, the index tanked, mostly due to bank stocks.
Now, in every investor’s book, financial stocks are supposed to be the strong ones, able to withstand whatever winds the market may bring. But, with major banks, along with a host of other financial institutions, loosing significant ground, the index had nowhere else to go but down.
So, what is causing financial stocks to belly flop and drag the TSX right with them? Well, we all like soaring energy and commodity prices, provided our portfolios are chock full of energy and commodity stocks. But, with commodities hitting the roof, there is also a more sinister link to something much less pleasant–rising interest rates.
Whenever commodity sectors rise significantly, particularly energy prices, if included in the consumer spending index, central banks are always on alert for inflation. One way to contain inflation is to increase interest rates. Rising interest rates have the potential to impact negatively performance of financial institutions. Hence the poor performance in the financial sector!
Last week, the Fed warned that it may have to continue raising interest rates to relieve inflationary pressures, while the Bank of Canada alluded to the same when it raised its key lending rate the last time on April 25.
To add insult to injury, weakness in the financial sector is occurring at the time when the sector’s profit growth is at seasonably low levels, and when loan losses have reached historically high levels, indicating credit quality of both individuals and corporations is worsening.
What is Canada’s stock market telling us? Well, central banks are getting scared. They are afraid of debt, deficits, deteriorating credit, rising energy prices, inflation, and who knows what else. Investors are also afraid because their savings are mostly non- existent, and their debts are huge, costing each month more and more to carry.
And, what’s the only thing left that is “tried, tested and true,” to borrow a slogan from last year’s Chevy commercial? Commodities, of course, be it gold, silver, copper, zinc, whatever! And, to rephrase Bunker Hunt’s much more famous slogan, buy anything with tangible value because “any darn fool can ‘print’ paper!”