“The future is no more uncertain than the present.” — Walt Whitman

“If you come to a fork in the road, take it.” — Yogi Berra

The tsunami caused the market to hesitate its advance but the trend was not toppled.

In the first quarter of 2011, the world’s stock markets generally continued the upward trend established over the last two years. The Toronto Stock Exchange reported a total return for the quarter of 5.6% of which only 0.1% was contributed in March following the fallout from the uncertainty caused by the disaster in Japan. The US markets as measured by the S&P 500 Index posted a total return of 5.9%. Due to the appreciation of the Canadian dollar over the quarter, the return as expressed in Canadian dollars was 3.0%. Global markets outside of the Americas were more effected by the Asian crisis. The EAFE (Europe, Asia and Far East) index appreciated 3.5% in US dollar terms but when expressed in Canadian dollars the return was reduced to 1.0%.

The bond markets did not entirely share the equity markets’ enthusiasm. For the quarter, the 91 day T-bill index recorded a return of 0.3% while the overall bond market as measured by the DEX Index was -0.3% due to yields increasing in the period. Note that this decline in the bond market is less than the decline in the final quarter of 2010.

Investors continue to seize on the positive developments in the economy while largely discounting many of the negative developments and geo-political events.

During the quarter, there was much to concern investors. Rising commodity inflation has yet to find all of its way into consumer price inflation. Base metals prices continued to rise as investors perceive that demand will continue to grow from increasing production in the emerging economies; particularly China. Oil prices spiked up in the quarter in reaction to the unfolding political instability in Africa and the Middle East. This rise in the price of oil was reflected in the price at the retail gas station. Largely as a result of floods and other natural catastrophes last year, world food prices and commodities related to dry goods production are up sharply. The competitive landscape in the retail environment has largely constrained retailers from passing on these costs but towards the end of the quarter several grocery retailers began to announce forthcoming price increases.

Following the devastating earthquake and tsunami in Japan, commodities and the global equity markets temporarily retreated, as the first inclination of investors was to run for cover. Although the natural disaster was the perhaps the catalyst for this retreat, the run up in commodity prices was also cause for growing concern as to the impact increasing prices would have (particularly oil prices) on choking the economic recovery. Adding to these inflationary concerns looms the prospect of tighter monetary policy in the US and Europe. Interest rates have increased most noticeably in the most troubled European economies; Greece, Ireland, Portugal, Italy, Spain and the UK. In the wake of these concerns, gold and silver prices hit new highs in the quarter.

So, what has caused the equity markets to remain so resilient to these economic, geo-political and natural disruptions?

Despite all of these events, the economic recovery has not been derailed as yet. Corporate profits continue to increase at a healthy pace although at a lower rate than last year. The activity in mergers and acquisitions was very robust most notably in energy (Petro China/Encana, BP/Rosneft), pharmaceuticals (Valeant/Cephalon, Sanofi Aventis/Genzyme), technology (Goldman Sachs/Facebook, Mogan Stanley/Twitter, AOL/Huffington Post, AT&T/T-Mobile) and stock exchanges (London Stock Exchange/TMX Group, New York Stock Exchange/Deutsche Bourse). Some of the recent employment figures from the US have been encouraging, although overall unemployment remains a problem. Productivity in the US has been very strong.

In Canada, the strong commodity markets have been a positive push on the equity market. Although the Canadian dollar continued to appreciate against the US dollar, it will likely be more range bound going forward. Interest rates in North America have been more benign than in Europe thus adding to the attractiveness of Canadian equities.

Going into the remainder of the year, investors should watch for: continuing gains in corporate profits, slower economic growth globally as many of these economic and political factors will weigh on business investment, rising interest rates as monetary policies tighten in North America and austerity measures are forced in Europe and some inflationary pressures on consumer prices.

So, are we heading for a crossroads? Will the economic recovery continue and be strong enough to absorb the political instability in the Middle East, economic hardships in Europe, shortages caused by the crisis in Japan, rising inflation and interest rates, and, the massive debt accumulation in the US? Stay tuned.

Although we do not foresee a smooth ride for the remainder of the year, the volatility in equity markets will open some opportunities for long-term investors. The good news is that the world economies continue to stabilize and strengthen and in time equity valuations will reflect the increasing profitability.


“It’s a terribly hard job to spend a billion dollars and get your money’s worth.” — George M. Humphrey

During the first quarter markets were buffeted by high profile headlines of political upheavals, natural catastrophes, continuing sovereign debt issues and rising inflationary pressures.

The rolling wave of popular revolts across North Africa and the Middle East had a conflicting impact on markets. The turmoil and the military intervention in Libya resulted in a flight to the safe harbour of the US dollar and Treasury securities, driving down interest rates, albeit temporarily. At the same time, oil prices rose speedily to new triple digit heights for the first time since the recessionary lows of 2009. This raised the spectre of higher inflation and its potential to choke off the economic recovery.

From a fixed income perspective the European community remained a concern. Ireland, after stress testing its banks has indicated that they need a further 24 billion euro capital injection. Greece, while currently out of the headlines, has not been able to provide a credible long term solution to its debt problems. In light of this, observers have suggested that instead of delaying the inevitable, a controlled default or restructuring would be preferable. In Portugal the government fell on the question of proposed austerity measures, with the consequent crisis of confidence driving borrowing rates to new euro-era highs.

The tragedy in Japan can be expected to have far broader repercussions than the immediate impact on the island nation. The disruptions caused by the destruction, rolling blackouts and concerns about radioactive contamination have exposed the limitations of just in time inventory management. These supply disruptions started to have a broader impact as auto part and electronic component shortages began to be felt around the world. An additional concern is the potential large scale liquidation of foreign currency denominated investments by insurance companies, corporations and individuals as the recovery and reconstruction process begins and funds are repatriated to fund these activities. These events may well act to depress security valuations.

The Federal Reserve’s second quantitative easing, their program of buying government securities as a means of holding down interest rates and providing extra liquidity, is scheduled to expire in June. Recent comments indicate that while the Fed remains committed to a low interest rate policy, it has become more sensitive to building price pressures around the world. These conflicting factors will likely be driving policy discussions regarding the need and timing of interest rate hikes.

The totality of these events bolster the case for a likely rise in interest rates for which our defensive posture of holding short-term, high quality fixed income investments is a prudent preparation.

The total return performance of the bond market as measured by the DEX Universe Index for the first quarter was a loss of 0.3%, as a result of a broad based sell off in the bond market. The ten-year Government of Canada bond yielded 3.3% at quarter-end, an increase of 0.2% over the course of the first quarter.

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