Market Commentary – April 2012

Markets take a breather in April

After posting strong gains in the first quarter of the year, equity markets retreated in April as investor concerns over the European debt crisis returned. The MSCI Europe Index dropped by nearly 3% after credit ratings agencies downgraded Spain’s debt with a negative outlook, hinting that further rating cuts may be coming. Spain paid a heavy price for this downgrade with the MSCI Spain Index plummeting by more than 13% in the month.

With the European debt crisis on the back burner in, global markets were relatively calm in the first quarter. As investor attention refocused on the crisis, markets were whipsawed in a way that was reminiscent of the volatility experienced in 2011. Investors raised concerns that the government may not be able to push through the necessary austerity measures and reforms with a shrinking economy and a restless population. Failure to implement these measures could result in the country’s inability to meet its targets, forcing it to seek a financial rescue similar to Greece, Ireland and Portugal. If this were to happen, the likelihood of Italy needing a bailout is expected to rise significantly.

Markets were rocked by worries that French President Nicolas Sarkozy would lose his country’s election to socialist candidate Francois Hollande. Hollande’s victory puts many of the positive steps towards reform that had been implemented in jeopardy. Greece was also in the spotlight as opposition parties have been unable to form a coalition government. Without some sort of a coalition in place, it is doubtful that many of the critical economic reforms that were agreed to under the previous bailout deals would not be implemented, putting the deal in jeopardy.

Closer to home North American markets, while down, fared relatively well in comparison.  The S&P/TSX Composite lost 0.74% in the month, which brings the year to date gain down to 3.65%. Energy and materials, which combined make up more than 45% of the index, have suffered recently from softening economic conditions in emerging countries, particularly China, where the government has tried to engineer a soft landing in order to ease inflation pressure. This has been one of the key reasons why the Canadian index has failed to keep pace with its U.S. counterpart.

Gold lost ground in April for the third consecutive month after data showed that the U.S. economy was on the road to recovery, reducing the likelihood that the U.S. Federal Reserve will enact another round of quantitative easing. Such stimulus measures typically put inflationary pressure on the economy, resulting in higher demand for gold, given its traditional appeal as a hedge against inflation.

In the U.S. the S&P 500 dropped 0.74% in U.S. dollar terms. Even with this modest loss, the index is up more than 11% on a year to date basis.

As the volatility returned to the equity markets, bondholders were the benefactors with rising prices and lower yields. The DEX Universe Bond Index rose by 0.13%. Not surprisingly, government bonds outpaced corporate bonds, as investors tend to favour their safe haven appeal in more volatile times.

Looking forward, we expect that the next few weeks will be volatile, based on the renewed uncertainty about the regions debt crisis. Closer to home, Canada and the U.S. are expected to continue to show signs of economic growth, but some level of slowdown over the summer is not unexpected. Valuations for equities appear reasonable, and for long term investors offer a more favourable return profile than bonds. That said, fixed income should continue to be an anchor in most portfolios, providing stability in times of uncertainty. Interest rates will be moving higher, but likely that is still a quarter or two out.

For the month of April, the best and worst performing funds were:

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