Interest rates and the bond market
Few thought at the beginning of 2011 that interest rates would be lower at the end of the year than at the start. However a non-stop slew of highly-volatile events ranging from the Japanese Tsunami, to the Arab Spring, debt ceiling negotiations in the US Congress and sovereign debt crises in Europe, combined with overall economic sluggishness to force global central banks to keep interest rates low to compensate.
Real interest rates (when inflation is taken into account) on several types of sovereign debt are now below zero. That means that those who invest in these securities actually lose purchasing power. This has led one commentator to joke that sovereign bonds now offer “return free risk,” instead of “risk free returns.” Government of Canada securities may fall into that category: two, five, 10 and 30 year bonds, yield only 0.97%, 1.32%, 1.98% and 2.5% respectively.
Global economic sluggishness during 2011 and weak expectations for 2012, kept downward pressure on Canadian equities during much of the last twelve months, which were also characterised by wide market swings. Commodities stocks in particular have been hit hard due to sluggishness in several export markets which have been large consumers of Canadian raw materials.
The S&P/TSX closed the year down (by 11.07%). This sluggishness, in addition to the overall market volatility is pushing investors to increasingly favour higher dividend yielding stocks such as utilities. In fact the S&P/TSX is so attractively priced right now, that the average component company yields XX% in dividends. That’s a higher rate than what is being paid out on ten-year bonds, the first time in 50 years that has occurred.
US markets also traded sideways during the year, due to many of the same reasons that Canadian equities did, notably a weak global and weak domestic US demand. Things are likely to only improve slowly. Congress remains hogtied and unable to push through the major stimulus efforts that many experts believe are needed to cut unemployment faster and to stimulate consumption.
One major market exception was the Dow Jones Industrial Average which gained ground slightly, due to a flight by investors to higher quality stocks. The broad-based S&P 500 for its part ended the year virtually unchanged. That may not sound too good, however these stocks proved to be an island of stability relative to European and Japanese issues, which have been struggling with far worse problems.
As noted previously, equities in many major advanced ex-North American economies lost ground during the year. In Europe the CAC, DAC and FTSE lost 15.3%, 12.1% and 5.6% respectively, due in large part to weakening domestic demand, coupled with continued uncertainty regarding the sovereign debts of countries such as Greece and Italy. This uncertainty is likely to persist into the New Year, due to the ineffectiveness of European decision making structures in responding to crises.
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Peter Diekmeyer Communications Inc.