Quarterly Market Commentary – First Quarter 2012


“Hope is the feeling you have that the feeling you have isn’t permanent.” — Jean Kerr

The title of our last commentary was “Cautious Optimism”. The thesis was that despite the myriad of problems yet to confront the world economies, there was some hope that severe calamities could be avoided given some evidence of strengthening trends in various economies. Little did we suspect that investors around the globe would glom onto these positive indicators and propel the global markets to such a great extent.

The Toronto Stock Exchange carried the positive momentum of the prior quarter though this quarter recording a gain of 4.4% supported in part by strengthening prices in commodities (Oil +14%, Gold +6%, Silver +16%, Copper +12%, Oil +14%, Natural Gas -31%), Canadian insurance companies (+22%) and some takeover activity (e.g. Viterra). The US market was particularly robust with the S&P 500 advancing 12.6% in total return for the quarter; the best quarterly advance since 1998. The US dollar fell 1.8% relative to the Canadian dollar. This strength in the Canadian dollar resulted in the total return of the S&P 500 being 10.6% in Canadian dollars. The respite in the European markets caused by the avoidance of a meltdown in the Greek market, along with the apparent growth left in the world economies, albeit slower than hoped in China, propelled the MSCI EAFE (European, Asian and Far East) Index to advance 11.0% in US dollar terms or 9.0% in Canadian dollar terms.

In response to this apparent euphoria over the prospect of better economic conditions, the fixed income markets did not fair so well relative to the equity markets. The bond index posted a negative return of 0.2%. Shorter term 91 day T-bills earned a meagre positive 0.2%.

Such optimism in the world markets is not entirely unfounded. US firms have been hiring more workers and consumer spending has advanced modestly. As stated, the persistent problems in Greece have been thus far handled without any major disasters that would have the potential to contaminate the other Euro members.

Yet, the markets have advanced to such an extent that the title of this commentary could well have been “Waning Cautious Optimism”.

Although evidence of a recovery in the US economy is mounting and encouraging, the pace of the recovery is weak and many structural problems remain. House prices have been more stable but are still declining in many areas as the inventory from the crisis is still working through the system. As consumers have de-leveraged, credit available to those consumers has expanded largely abetted by the continuing low interest rate environment that will not prevail in a more robust economy and, extended tax cuts as politicians are reluctant to act during this election cycle. Forecast rates of growth in the US economy are far below those typically expected following a recession.

With the exception of Germany, Europe remains mired in a recession stemming from the massive fiscal problems of its members. The central bank has staved off a major collapse through the provision of liquidity to the banks, but this scheme cannot last indefinitely. Although the crisis in Greece has been quelled for the time being, there is already talk of further bailouts being required. As austerity programs become the norm in Europe, the potential for any meaningful economic growth is pushed farther into the future. It is hoped that the European recession will be maintained at a relatively modest level, as the problems in Italy, Portugal and Spain are yet to come to the forefront.

Political instability continues to spread in the Middle East causing oil prices to maintain an upward bias. In the emerging economies, tightening monetary conditions are hampering growth expectations. If the US economy can continue to exhibit progress and the European economies stabilize, exports from the emerging economies may recover to some extent.

In light of the above factors, our “Cautious Optimism” has temporarily waned, but not disappeared. The advances of the first quarter may give way to periodic shocks as the systemic problems in the global economies are addressed. Austerity measures will continue to prod civil disobedience in Europe. Little in the way of serious measures to stymie the growing deficit in the US economy are likely to occur until after the election in November. Commodity prices will continue to be reactive to the changing perceptions of the rates of growth in the emerging economies.

The resulting volatility in the equity markets will prove challenging to investors. Those investors prepared to act on significant opportunities, as they undoubtedly will occur, will be rewarded.


“It is the debtor that is ruined by hard times.” — Rutherford B. Hayes

While the world economies exhibited signs of improvement, particularly in the US, and fears of bond defaults moderated in Europe, the demand for US Treasury securities abated as the perceived need of a safe haven declined.

In Europe, agreements between Greece and its lenders, removed the existing obstacles that would have prevented the release of funds to Greece by the European Union and the International Monetary Fund. As a result, the probable event of a Greek default that would have produced ripple effects throughout Europe has been forestalled. While this is positive in the short term, the longer-term issues of dealing with significant deficits and debt remain. Nevertheless, the fixed income markets were relieved by the reduction in the uncertainty of an imminent default, thereby reducing the flight to quality demand for US Treasuries as indicated by the rise in yield on the ten year benchmark issue to 2.4% by March from 2.0% at year end.

The Federal Reserve confirmed their continued support for low interest rates through pronouncements made in light of the moderate pace of improvement in economic fundamentals and by the persistently high unemployment rate. However, there does appear to be some dissent amongst members of the Federal Reserve as to the need to maintain low rates as Chairman Bernanke referred to a “disappointing recovery”, while other district governors mused that further stimulus will not be required. Overall, the consensus appears to be that as long as the US economy continues to improve and inflationary pressures remain contained, the Fed will neither hike rates nor inject further stimulus.

The Governor of the Bank of Canada and other finance officials have for some time been warning about the level of indebtedness of Canadians. The timing of the major Canadian banks rolling out 2.99% mortgages was therefore an unwelcome response to these concerns. Officials are faced with a fine balancing act of attempting to reign in the increase in debt, especially mortgage debt, while at the same time, minimizing the impact on the housing market. Recommendations for higher down payments and shorter amortization periods were all aimed at moderating the growth in consumers’ mortgage exposure.

The total return performance of the bond market as measured by the DEX Universe Index for the first quarter was a loss of 0.2%. The ten-year Government of Canada bond yielded 2.1% at quarter-end, an increase of 0.1% over the course of the quarter.

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