Quarterly Market Commentary – Third Quarter 2012


“An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” — Laurence F. Peter

In the third quarter of 2012, investors largely ignored a steady stream of data portraying contracting and slowing global economic output. By the end of the quarter, the World Trade Organization reduced their forecast for global commerce growth to 2.5% from the 3.7% that they had postulated just five months previous. The International Monetary Fund (IMF) is reviewing their previous estimate that world GDP would grow by 3.5% in 2012; the slowest rate of growth since 2009. Despite indications of diminishing economic growth, the markets reacted as illustrated in the following table:


Throughout the quarter, the problems for aid, Spain’s woes continued to increase as the initial estimates of 100 billion Euros required to shore up the Spanish banks swelled to levels not yet defined. Output declined in Italy, Spain and Finland. In Greece output contracted by 6.2% year over year; the fourteenth contraction in fifteen quarters. The Organization for Economic Co-operation and Development (OECD) forecast that only the German economy would see better employment rates by the end of 2013. Initial estimates reported that Britain’s economy was also shrinking. Moody’s threatened to cut Germany and Britain’s AAA credit rating but relented for the time being.

The IMF cut its forecast for the growth of US GDP as well. Throughout the quarter, statistics relating to job creation and manufacturing output continued to disappoint. In one of their communications, the IMF referred to the need for the US to address the “fiscal cliff” that they are approaching. Uncertainty surrounding the outcome of the presidential election will persist and prohibit any real action being taken until after the election.

Other global economies have felt the effects of slowing or contracting conditions. In Japan, record trade deficits were recorded. In Brazil, consumer defaults on loans surged.

While investors have been concerned about the slowing economy in China and the collateral effects on commodity demand, with a few exceptions (metallurgical and geothermal coal, uranium, potash, NSBK pulp), commodity prices have generally had a positive quarter.

The financial markets have also been buffeted by scandal in the quarter. The CEO of Barclays resigned in the wake of revelations that the bank participated in fixing LIBOR rates (rates that are used as the basis on which many other lending rates are determined). The CEO of Nomura Securities resigned over insider trading allegations. In the US, Knight Capital required a $400 million bailout resulting from trading errors that cast high frequency trading in a negative light.

So why have stock markets surged while economies have floundered?

Following the negative results posted in the second quarter, many stocks had fallen to levels that investors perceived that much of the downside risk had been mitigated or overly discounted. Dividend yields remain compelling relative to yields in the fixed income market. Investors also responded positively to the efforts of both central bank authorities and political leaders to stem the continued decline in economic activity.

Central banks around the globe responded to the disappointing economic performance in what appeared to be a more co-ordinated fashion. In Europe, austerity measures persisted. Central bank interest rates were cut in Korea, Brazil, China, the Euro-zone and the UK. The Bank of England continued purchasing assets to shore up the domestic banks. European officials proclaimed that they would do “whatever it takes” to save the Euro. In the US, investors greeted Mr. Bernanke’s long awaited announcement that QE3 (asset purchases) would be undertaken to support the economy. US housing markets exhibit signs of stabilizing while Canadian housing markets indicate some signs of slowing. However, the Canadian markets were bolstered by stronger prices in material, energy and agricultural commodities.

Going into the final quarter of 2012, we anticipate more of the same. Investors will be reactive to the ongoing trials and tribulations in the global economy while government officials attempt to stabilize economies with as little austerity as possible. Overall, we believe that conditions will be affected by the drag from lower spending levels in the public sector while the private sector adjusts to slower growth and diminished expectations. The stock markets will be buffeted by positive and negative events, providing opportunities to astute, prepared participants.

Quarterly Market Commentary -THIRD QUARTER 2012 FIXED INCOME

“Let us all be happy, and live within our means, even if we have to borrow the money to do it with.” — Artemus Ward

While the focus of investor concerns continued to centre on Europe, much of the concern over the quarter was around the question of whether or not the Federal Reserve in the US would engage in another round of quantitative easing for the third time since the financial crisis started; QE3.

Finally, in early September, investors were relieved by the announcement that indeed, QE3 would happen. QE3 will entail further purchases of mortgage backed and other securities to provide liquidity to the financial sector in anticipation of better economic growth. The last two rounds of quantitative easing have resulted in diminishing returns in terms of the stimulus provided to the private sector. It is uncertain whether the third round will prove sufficient to see the economy improve to the extent that subsequent rounds will not be required.

Overall US labour, employment and manufacturing indicators have been sluggish throughout the quarter. The weakness of the economic recovery has only been partially offset by signs of more stability in the housing market and some improvement in the service sector. Meanwhile, political focus has been distracted by the upcoming election so little will likely be done to address the fiscal imbalances causing the massive accumulation of public debt as the private sector struggles to de- leverage the excesses of the last cycle.

Investors that would normally shun such fiscal imprudence have been more than happy to maintain a robust appetite for US treasuries given the unappealing alternatives. On the positive side, the European Central Bank (ECB) has demonstrated more cohesive commitment to maintain the Euro by doing “whatever it takes” and Germany has been more receptive to participating in aiding this effort. On the negative side, conditions in the problem countries continue to deteriorate. As yet, austerity measures have been insufficient to address the structural cracks caused by living for too long beyond their means. The addiction of borrowing has prolonged the illusion of stability. Now that the music has stopped, real solutions will be required. Civil unrest has the potential to accelerate and postpone stabilising economic conditions.

The emerging economies of Brazil, Russia, India and China continue to exhibit signs of slowing but paradoxically commodity prices generally improved in the quarter.

Spreads between corporate and government securities proved to be relatively resilient to any signs of economic deterioration, declining slightly as hopes for continued improvement lingered.

The total return performance of the bond market as measured by the DEX Universe Index for the third quarter was a gain of 1.2%. The ten-year Government of Canada bond yield was unchanged at 1.7%.

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