Third Quarter 2011
Interest rates and the bond market
Uncertainties regarding the European debt crisis and US fiscal policies caused the worlds central banks to maintain extremely loose monetary policies during the third quarter. Real lending rates (interest rates less inflation) in most western countries are near or below zero. Several countries, including Canada and the US, have pledged to keep rates low for the foreseeable future. Bond rates are thus also at rock bottom, with the two, five and ten-year yields at 0.91, 1.75 and 2.15 percent. These levels are all far below the dividend payout levels of key major corporations, leading many analysts to favour equities over fixed income investments.
Wide uncertainty on the international environment pushed down major global equities indices during the third quarter including the S&P/TSX, which fell by 12.6%. The nervousness stemmed primarily from two sources. First is Europe, which is in the midst of a long and arduous process to get together a stabilization plan to help its weaker peripheral economies. Weak and cumbersome governance processes there are however proceeding slowly, and members have pledged to resolve the issue by November.
On this side of the pond, the United States continues to shrug off the effects of the downgrade of its debt by Standard & Poor’s. Markets aren’t too worried about America’s capacity to pay back its creditors (American bond prices actually rose after the downgrade). However they are concerned about paralysis in Washington political decision making circles, which the debt rating agency said was the key reason underlying its decision.
These dual concerns increased investor concerns that a global recession was in the cards, which would dampen demand for Canadian raw materials and other export goods. These concerns also drove down the Canadian dollar.
Broad US equity indexes also took a hit during the past quarter due to the uncertainties noted above. This drop was compounded by extreme market volatility, with ETF and high frequency trading consistently account for the vast majority of activity in US exchanges. This has led to an unusual number of trading sessions with triple digit point swings in the DJIA. As a result, the amount of money held on the sidelines by patient investors continues to accumulate. This bodes well for equities multiples when things begin to turn around.
Foreign markets also took a beating during the third quarter. The UK’s FTSE and Japan’s Nikkei indexes fell by 11.36% and 13.74% in local currency terms. Eurozone stocks fared even worse, due to uncertainties over member sovereign debts. For example the France’s CAC and Germany’s DAX indexes fell by 25.13% and 25.4% respectively.
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Peter Diekmeyer Communications Inc.