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Market Review

Fourth quarter 2012

 

Fixed income

 

In a year filled with uncertainties ranging from the future of the euro to whether the United States government would pay its debts or would hit a fiscal cliff, equities markets did reasonably well. However bond investors paid the price.  “Financial repression” by central banks, which have been firing up the printing presses as never before, have kept yields exceptionally low in almost all major global markets.

 

In the United States Federal Reserve Governor Ben Bernanke recently announced a “QE Infinity” quantitative easing policy, which includes close to a $1 trillion in annual financial asset purchases for the indefinite future. The US did get some good news as the year drew to a close when Congressional Republicans and Democrats agreed on a budget deal to avoid the country falling over a “fiscal cliff.” However the worry in markets is that many Republicans, frustrated at having to agree to tax hikes as part of the deal, will prove obstructive during the upcoming negotiations to raise the country’s debt ceiling.

 

Europe too has been undertaking measures to loosen the money supply, to help ease concerns about the sovereign debts of several member economies. Japan too, which has been easing money for some time recently elected a highly nationalist Liberal government led by Shinzo Abe, which has made significant commitments to boosting inflation there.

 

These moves have had repercussions here in Canada where the central bank has been forced to more or less follow suit. The upshot is that Canadian corporate bond yields continue to trade at exceptionally low levels. Nominal interest rates on Canadian government bond have also been low with two, five and ten year treasury issues closing the quarter yielding 1.15%, 1.41% and 1.83% respectively. In real terms (after inflation) yields are in negative territory.

 

Equities

 

Canadian markets

All told Canadian equities did reasonably well, particularly on a total return basis. The S&P/TSX rose to 12433 up 478 points or 4.0% during the year (XX% when dividends are included). Stocks thus outperformed bonds by a significant margin. The difference is even wider after-tax as equity income (dividends and capital gains) taxed at lower rates than interest income.

 

US markets

US stocks which comprise a significant portion of many Canadian balanced equity portfolios did exceptionally well during 2012, as is often the case during Presidential election years. The S&P 500 gained 13.41% in local dollar terms, XX% when dividend income is included. The gains occurred despite the relative weakness in the US economy. This weakness abated somewhat as the year progressed, led by the automotive and housing sectors. The fact that many large US companies generate a significant portion of their earnings in emerging markets, which have been growing faster than developing economies, has also helped.

 

Foreign markets 

There was also good news coming from foreign markets, particularly Europe, where London (FTSE), Paris (CAC) and Frankfurt (DAX) made significant gains rising by 5.84%, 13.0% and 25.3% in local dollar terms (before dividends). That said, European economies remain weak, and most of the equity returns can be attributed to optimism stemming from central bank money printing, which has eased sovereign debt concerns.

 

Japanese markets too performed well during the year, due in part to the coming of a new government which has set ambitiously high inflation targets. These should work to devaluing the yen, which would boost the export competitiveness of Japanese firms in foreign markets, especially European countries, many of which are major clients.

 

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