INTEREST RATES AND BONDS – 4TH QUARTER 2016 FIXED INCOME COMMENTARY

“Last year we said, 'Things can't go on like this', and they didn't, they got worse.” ~ Will Rogers

Interest Rates and Bonds: After peaking in the summer, the bond market’s direction has decidedly deteriorated. In December the US Federal Reserve started its widely expected tightening by raising the Fed Funds rate 0.25% to 0.50%. Further interest rate hikes will likely proceed at a moderate pace as dictated by economic conditions. According to the commentary emanating from Federal Reserve governors and other pundits indicates that the consensus view is that historical interest rate lows are behind us.

interest rates bond market direction deterioated

Interest Rates and Bonds – After peaking in the summer, the bond market’s direction has decidedly deteriorated.

Mr. Trump's unexpected election win is causing some uncertainty as to the economic agenda going forward. His promises of corporate and personal tax cuts, increased military spending and infrastructure investment will have to be funded through increased borrowing that would normally be expected to be inflationary. In addition, his penchant for random Tweeting has, and will likely continue to cause, turbulence in the markets.

European concerns continue. The Italian banks' need for recapitalization, the most notable being the insolvent Banca Monte Paschi di Siena (the world's oldest and Italy's third largest bank), has called into question the viability of the entire Italian banking system. As it stands, approximately 18% of Italian banks' loan portfolio is non-performing.

Italy’s problems dwarf those of Greece. Italy is the third largest economy in Europe. A banking crisis in Italy will require all the resources of the European Union. The strapped Italian government simply does not have the resources to recapitalize some, or all, of its banking sector. Questions as to the continued viability of the European Union are multiplying.

In 2017 elections will be taking place both in France and Germany. These two countries have been traumatized by terrorist attacks and they have been severely impacted by the immigration crisis. Nationalist sentiment and anti-immigrant rhetoric have exacerbated tensions.

Indications are that Canadian government borrowing and deficit spending will be of longer duration that originally indicated. Increased borrowing and similar spending policies in the US should keep the interest rate differentials, and hence the exchange rates, between the two countries in a relatively tight range, unless Mr. Trump's policies result in significantly increased economic growth and job creation in that country.

The total return performance of the bond market as measured by the FTSE TMX Canada Universe Bond Index for the fourth quarter was a decline of 3.4%. 91-day Treasury bills returned 0.1% over the same period. The benchmark ten-year Government of Canada bond yield increased 0.72% over the course of the quarter to end with a 1.72% yield at year-end. Over the course of the quarter the Canadian dollar depreciated by 1.7 cents from 76.2 cents US to 74.5 cents US.

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The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.  

 

Stock Market Outlook 2016 – Brexit Decision

Stock Market Outlook 2016 – Can Politics Trump Economics?

“Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies.” –Groucho Marx

“The expected rarely occurs and never in the expected manner.”- Vernon A. Walters

It didn’t go the way the pundits predicted. As the second quarter came to a close, people in the UK voted to exit (Brexit) the European Union by a narrow margin. Despite the narrow differences in the polls, global markets and the mainstream press indicated that the opposite outcome would prevail in the days leading up to the vote.

Investors hate uncertainty. The immediate reaction to the Brexit vote was severe and negative. However, stocks recovered to a great extent over the following week.

Stock Market Outlook 2016 Brexit decision

Stock Market Outlook 2016 – Brexit decision will continue to weigh on market sentiment for some time.

In North America, stock markets ended the quarter in positive territory. The Canadian market was up considerably with very strong results in the Materials (+26.9%), Energy (+9.5%) and Utilities (+7.0%). The laggards in Canada were primarily in Health Care (-15.3%) and Information Technology (-5.9%). In the US, Energy (+10.8%), Utilities (+5.9%), Telecommunications (+5.9%) and Health Care (+5.8%) lead the way while Information Technology (-3.3%) and Consumer Discretionary (-2.0%) lagged.

Canadian Dollar


               US Dollar
Q1 Q2 Q3 Q4 YTD Q1 Q2 Q3 Q4 YTD
Toronto Stock Exchange 4.5% 5.1% 9.8%
S&P 500 -4.7% 1.9% -3.0% 1.3% 2.5% 3.8%
MSCI EAFE* -9.5% -3.2% -12.4% -3.7% -2.6% -6.3%
91 Day T-Bill 0.1% 0.1% 0.3%
CUBI** 1.4% 2.6% 4.1%
CDN/US dollar 6.7% -0.3% 6.4%

* Europe, Asia and Far East Index

** Canadian Bond Universe Index

The Brexit decision will continue to weigh on market sentiment for some time. The vote result was a wake-up call to politicians of every stripe as the rationale for the outcome is debated and dissected. The vote reflects an underlying current of discontent within populations in the developed democracies as politicians have sought to engender resentment over wage stagnation, disappearing jobs and a growing inequality of outcomes. (Politicians looking for trouble and finding it everywhere.) The result has been a focus on the very trends that have sustained wealth and economic growth over the post-WWII period: globalization, free trade and migration. The same style of political rhetoric is evident in the US as they prepare for the presidential election in November.

While a divorce from the European Union, if indeed it ever comes to fruition, may take years to negotiate, investors will deal with the inherent uncertainty that will surround the negotiations. In the immediate aftermath of the vote, volatility increased as did bond prices as yields spiked lower and the US dollar increased in value along with gold as investors sought a safe haven. The British Pound is hovering near a thirty year low against the US dollar. Once the initial shock had subsided, share prices recovered as investors became reconciled to the fact that this will be a long process, the results of which may not be as devastating as the pictures painted by pundits prior to the vote.

Although overshadowed by Brexit at the end of the second quarter, other things of note were occurring during the period.

As noted in our last Retrospective and Prospective, the Federal Reserve in the US had gone from a more aggressive posture with respect to raising interest rates to a less certain posture by the end of the first quarter. In the second quarter, more evidence of a slowdown or weaker economy is likely to reduce the prospects of higher interest rates even more. On the positive side, the first quarter GDP figure was modestly higher and housing markets appeared to be firm. More banks passed tests of capital adequacy, improving prospects of dividend increases. However, both industrial production figures and capacity utilization figures disappointed investors as did unit labour costs and productivity numbers. Employment figures disappointed with large withdrawals of people from the workforce. Manufacturing inventories were higher than expected while auto sales declined.

Commodity prices strengthened over the quarter bolstering the shares of Material and Energy companies.

Companies announced a number of employee reductions, including Daimler, the London Stock Exchange, Ralph Lauren, Wal-Mart and Dow Chemical.

In Japan, sales tax increases were postponed due to fears of a weakening economy in the face of lower machine orders and lower exports.

In this environment, the yields of stronger issuers were pushed lower. In Germany, the 10 year bonds went into negative territory and Swiss bonds were driven to a negative yield all the way out to 50 years. There are now in excess of US$10 TRILLION in negative yield bonds in circulation!

Stock Market Outlook 2016 – In this environment, what is an investor to do?

The dynamics and benefits of a diversified portfolio are evident. As we witnessed during the Brexit aftermath, when stocks retreated, the value of the US dollar, gold and bonds went up. Assets react to events and capital flows to where it is treated best. The interplay between bond yields, credit spreads, stock prices, currencies and liquidity will continue to be impacted by economic conditions, energy and commodity prices, changes in central bank and political policies and demographics. Technology will continue to change the shape and nature of employment. As much as the Luddites would like to turn back the clock and take isolationist stances, technology will advance domestically and abroad.

Over the longer term, there will undoubtedly be winners and losers. Stronger companies will survive and prosper. During the Brexit incident, we placed bids below the market in order to try and capture opportunities that may have been presented.

Investors that are prepared will prosper.

You can view and download your own copy of our complete market commentary here:

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The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.

 

Bonds – THIRD QUARTER 2014 FIXED INCOME COMMENTARY

“The job of the Central Bank is to worry.” ~ Alice Rivlin

Bonds – Fixed income markets in the third quarter remained relatively unchanged in line with continued expectations of a low interest rate environment.

Economic indicators continued to signal a modest, but steady improvement in the US. This will allow the Federal Reserve to continue with its phasing out the Quantitative Easing program in October. In the statement released subsequent to the September 16 / 17 FOMC (Federal Open Market Committee) meeting, it was indicated that they expected a more rapid increase in interest rates looking out to 2017.

Canada 10 year bond rates 2014

Bonds – the benchmark ten-year Government of Canada yield remained unchanged at 2.2%.

At the same time, European conditions are less rosy. There have been ongoing concerns about the spotty economic recovery and fears about the possibility of deflation manifesting itself. European Central Banker Draghi has vowed to ensure that adequate liquidity and stimulus will be available. This potentially pro inflationary stance, while understandable from the perspective of mitigating the risk of deflation, is fundamentally opposed by Germany given their painful historical experience with out of control inflation.

In Canada, the neutral language from the Bank of Canada regarding interest rates has combined with a modest rise in inflation to feed the erosion in the value of the Canadian dollar. Low interest rates have been fuelling growth in consumer debt and driving increasing house prices, especially in the hot Toronto and Vancouver markets. This has even gained the attention of the IMF, which expressed its concerns.

The various economic cross currents have left politicians and central bankers in a sticky situation. On one hand, they clearly do not want to increase interest rates in an uncontrolled manner that would choke off the uneven recovery. On the other hand, higher rates would tame debt growth and likely introduce some inflation that would allow them to retire debt with a devalued currency in the future. Of course monetary policy is not a precise tool and caution is warranted.

An issue that concerns us is the fundamental disconnect between investors reaching for yield by investing in potentially ever more risky investments. Italian and Spanish ten-year bonds for example are yielding less than equivalent US Treasuries. Similar distorted valuations are evident in high yield corporate bonds also. One needs to reflect on the question that perhaps investors are being lulled into a false sense of security and risk is once again being mispriced.

The total return performance of the bond market as measured by the FTSE TMX Canada Universe Bond Index (formerly DEX Universe Bond Index) for the second quarter was an increase of 1.1%. The benchmark ten-year Government of Canada bond yield remained unchanged at 2.2%. Over the course of the quarter the Canadian dollar declined by 4.4 cents from 93.7 cents US to 89.3 cents US.

You can view our equity market commentary here>>
You can view and download a complementary copy of our complete Third Quarter Retrospective and Prospective here:

The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.

Bonds – Which Way Rates?

Bonds – Fed Says Interest Rates to Rise in 2015. Are Markets Ready?

In the wake of the 2008 – 2009 credit crises, central banks around the world did their utmost to stabilize markets and economies by various methods. The ultimate outcome was an extraordinary low interest rate environment throughout much of the world.

Now that these unfortunate events have started to recede into the past, much speculation has occurred as to the direction of interest rates going forward.

Bonds Janet Yellen commitment maintaining low interest rates

Bonds – Janet Yellen confirmed commitment to maintaining the low interest rates–for now.

The Federal Reserve’s statement on Wednesday confirmed their commitment to maintaining the current low interest rate environment subsequent to the end of its Quantitative Easing (QE) program in October. Nevertheless, it is worthwhile to reflect on a couple of points. First, forecast of interest rates out to 2017 seemed to indicate a more rapid pace of expected increases than previously estimated. Secondly, investors generally ignored that central banks, including the Fed, have limited ability to influence longer-term bond and mortgage interest rates. Those rates are more strongly influenced by market forces.

If we consider the current interest rate picture, the stronger growth in the US does suggest that rates are likely to rise. In Canada, the decline in raw material demand and the coincident decline in the value of the Canadian dollar will likely act as a drag on domestic interest rates. That situation will continue at least until such time that either rate increases in the US start to have an impact or extraneous events impact financial markets.

Canadian 10 years bonds – yields have risen sharply since the beginning of September — see more here>>

Consider the various geopolitical factors at play in the global context. There is the lacklustre economic performance of Europe and the questionable fiscal strength of many southern European countries. There is also the potential of retaliatory pressure from Russia over EU plans to strengthen economic ties with the Ukraine. Russia is Europe’s major natural gas supplier. Currently European sovereign interest rates are extremely low. Italian and Spanish ten-year yields at 2.4% and 2.3% respectively are actually lower than equivalent US treasuries rates. To be fair, Greek bonds at 5.7% and German ones at 1.1% are well outside this range. Still, one needs to entertain the notion that perhaps such low rates do not fully reflect the true potential risk associated with those sovereign credits.

“The greatest trick European central bankers ever pulled was to convince the world that default risk didn’t exist” – Read more here>>

The US, although rejecting broader involvement, is nevertheless inexorably drawn into the Middle East vortex that has been spreading now with the extremist actions of ISIS. Despite protestations to the contrary, one cannot but wonder as to how much this renewed counter terrorism push will cost in lives and treasure. We doubt that US deficits will decline in the foreseeable future!

All this to say, interest rate pressures will be increasing over the coming months and years unless of course the world economy slides back into a recession or that some geopolitical catastrophy results in the now customary flight to quality into US Treasuries, and to a lesser extent Canadian government bonds.

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BONDS – THIRD QUARTER 2013 FIXED INCOME COMMENTARY

BONDS – THIRD QUARTER 2013 FIXED INCOME COMMENTARY

 “Nothing is so unbelievable that oratory cannot make it acceptable.”- Cicero

Bond fixed income markets higher rates

Bonds and fixed income markets continued their slow grind towards higher rates

Bonds and fixed income markets (after a negative second quarter,) continued their slow grind towards higher rates until the Federal Reserve postponed its tapering program causing what is expected to be a temporary reversal.  As a result, bonds were essentially flat in the quarter.

The initial reaction to the continuation of the “quantitative easing” program may have been positive but on further reflection, the implications are less rosy. The delay on tapering the stimulus may imply that the Federal Reserve considers the economy weaker than the market participants.  In any case, their lack of action after the buildup in anticipation, eroded that most precious commodity of central bankers – credibility. In our view, a modest reduction in the level of bond buying would have satisfied both the expectations of market participants, while having no meaningful negative impact on the economy.

The European situation seems to have settled down with modest economic improvements becoming evident. Still, high unemployment and crushing levels of debt remain and will have to be dealth with. In the meantime, another round of bailout for Greece will have to be decided on in November.

Germany’s leadership in this stabilization process was once again confirmed with Mrs. Merkel’s recent electoral success. Nevertheless, she is faced with crafting a coalition that may be less ameanable to her goals of extending continued support for Germany’s less stable Euro partners.

At quarter-end the spectacle of the US legislative process’s inability to come to terms with crafting a budget was faced by the market. It is likely that after further posturing some form of agreement will eventually be reached. Nevertheless, it is extremely unlikely that  both parties will agree to deal with the ongoing  deficits that continue to accumulate, in a meaningful manner.

It would appear that only some massive external shock will focus the attention of legislators on dealing with debt and deficits. Whether the reduction this summer in Japanese and Chinese purchases of US Treasury securities is an early warning sign or just a blip in international investment flows, remains to be seen.

The total return performance of the bond market as measured by the DEX Universe Index for the third quarter was a minimal gain of 0.1%. The benchmark ten-year Government of Canada bond yield increased by 0.1%, to 2.5%.

Read our third quarter equity commentary here>>

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