Quarterly Market Commentary – Second Quarter 2012


“The only function of economic forecasting is to make astrology look respectable.” — John Kenneth Galbraith

Investors’ confidence was shaken in the second quarter of 2012 by the onslaught of disturbing news emanating from the European fiscal crisis and some indications of slowing activities in the emerging markets and the US. After starting the year with very strong performance in January, the Canadian stock market reflected investors’ uncertainty evidenced by a lack of direction the next three months followed by a loss of confidence and downward direction in the last two months. The results of the first two quarters are illustrated in the following table:


In our last commentary we referred to “Waning Cautious Optimism”.

The ongoing uncertainty of any near term resolution to the woes of overspent governments in Europe has caused fears that the contagion could spread, catapulting Europe into a deeper recession or depression. Cyprus is now the fifth country to ask for aid. After some twenty European Council summits and fourteen emergency summits, investors are getting impatient to see more concrete steps taken to resolve the crisis. An inconclusive election in Greece and a sharp move to the left in the French election did not help to alleviate concerns. Signs of declining manufacturing activity in the US are also causing concern. Partially offsetting this concern are some initial signals that the housing market is stabilizing to some extent. US unemployment continues to inch down, albeit at a snail’s pace.

Commodity prices took a beating as these fears of slowing economic conditions caused investors to worry about weakening demand. Oil prices were particularly hard hit. The price of BRENT oil declined from $122.13 to $94.41 while WTI (West Texas Intermediate) prices fell from $102.56 to $85.02. Other industrial commodity prices fell as well; Copper from $3.83 to $3.49, Zinc from $0.91 to $0.85, Nickel from $8.09 to $7.57. Precious metals also declined as gold went from $1668 to $1597 and silver declined from $32.49 to $27.50. This quarter reflected the largest decline in gold prices in nearly four years. Despite some increases in agricultural commodities (Wheat from $6.61 to $7.39; Corn $6.44 to $6.67; Soybeans $14.03 to $15.13), the decline in most commodity prices combined with the general malaise in the market resulted in the Canadian dollar declining from just over par ($1.0009) against the US dollar to $0.9813. As investors fled to perceived safer havens, the US dollar became a place of relative refuge.

As the recovery clings to stay onside, the responses by government have been mostly disappointing to date. However, some recent actions have been more positive. In the US, the Federal Reserve has extended “Operation Twist” whereby they buy longer-term maturities in exchange for shorter terms with the intent to hold interest rates down. The central banks in Europe and Asia have reacted as well. The People’s Bank of China reduced interest rates for the first time in four years. At the European epicentre of the current crisis, Europe, the central banks are maintaining efforts to keep interest rates from climbing and more recent indications are that it is becoming more politically feasible to look towards a more centralized banking union.

Closer to home, The Bank of Canada remains committed to holding interest rates down in the near term in order not to stifle this fragile recovery. The federal government through the Office of the Superintendent of Financial Institutions (OSFI) has taken measures to cool the housing market domestically by shortening available mortgage maturities to a maximum of 25 years and limiting the amount of debt homeowners may have against their properties. While these actions will dampen consumer spending to some extent, these steps are prudent in light of the run up in consumer debt levels.

We expect that market participants will remain jittery over the coming months while the markets continue to react to mixed signals stemming from the current macro economic and political environment.

Our approach is to identify and act upon opportunities as they present themselves through the current period of uncertainty.


“Debt is the fatal disease of republics, the first thing and the mightiest to undermine governments and corrupt the people.” — Wendell Phillips

The events in Europe and the inability of sovereign governments to achieve consensus on ways to solve the issues, coupled with weakening economies, dominated the activity in the global fixed income markets during the second quarter.

Following an inconclusive election in Greece during May, a second trip to the polls was required before a workable government could be formed. The new Greek government remains pro-Euro and intends to stay within the currency block. After reading the mood of the electorate, the new government was forced to back track and seek extensions to debt repayment terms arranged by the previous government. While the creditors would prefer to resist these extensions, the alternative could result in even less debt recovery. As a result, some modification to the debt repayment schedule will likely be forthcoming. However it may be too late to prevent Greece’s exit from the currency union.

The idea of a greater pan-Euro fiscal, banking and political union has been suggested as a possible solution. In theory, greater centralized oversight of banking and lending under the auspices of a more centralized political entity would alleviate a number of the current issues. Realistically, many sovereign jealousies and obstacles would have to be overcome to get to this juncture. While the majority of Euro members would favour consolidated bond issues, Germany vehemently opposes any solution that would leave them on the hook for everyone else’s transgressions. It may take the near economic meltdown of Europe to bring everyone onside.

At their eagerly anticipated meeting in June, The Federal Reserve once again reiterated their commitment to keeping interest rates low. Therefore, Operation Twist was extended whereby short- term government debt is issued to purchase long-term government debt, which assists in keeping long- term interest rates low.

The bond market had clearly been anticipating that the Federal Reserve would announce another round of Quantitative Easing (QE) in order to further stimulate the economy. Like a drug addict looking for a quick fix, additional QE may well have caused some short-term relief. However, the Federal Reserve has chosen to refrain from this course of action which should prove to be more prudent in the long- term. In taking this approach, they have signalled their belief in allowing the economy a chance of healing while retaining the option of more stimulus down the road if required.

The total return performance of the Canadian bond market as measured by the DEX Universe Index for the second quarter was a gain of 2.3%. The ten-year Government of Canada bond yielded 1.7% at quarter-end, a decline of 0.4% over the course of the quarter as the Canadian market experienced a similar safe haven appeal as the US, albeit to a lesser extent given the smaller size of the available pool of securities.

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