Market Commentary September 2012

As was widely expected, central banks in the U.S. and Europe stepped up to the plate announcing aggressive bond buying programs to inject much needed liquidity into the economies in an effort to spur economic growth. Markets reacted positively with all markets showing gains in September. Thanks to this rally, all markets, except for Japan finished the third quarter in positive territory.

After vowing to do “whatever it takes” to save the Euro back in July, European Central Bank President Mario Draghi announced plans for an unlimited bond buying program for distressed government bonds. The plan for this program is to help to keep interest rates in check, buying more time for European governments to get a firm grasp on their debt issues. This plan will not solve the problems, but it will buy more time and provide a safety net for bond investors. The end result is that because of this, the tail risk has effectively been removed from the European crisis. While volatility is expected to remain high while the crisis is sorted, the likelihood of a blowup or collapse is greatly reduced.

Closer to home, the U.S. Federal Reserve launched their third attempt at quantitative easing, announcing the much anticipated, if not originally named, QE3 program. Under this plan, the Fed will buy up to $40 billion a month of agency mortgage backed securities. Unlike previous QE programs, this one has no definitive end and they will continue to buy these bonds until they see economic growth and an improved employment picture. As part of this plan, they expect that short term interest rates will remain exceptionally low through at least 2015. This stability in interest rates proved to be positive for bonds, which saw the DEX Universe Bond Index modestly higher by 0.67% in September.

During the month, gold gained more than 5%, closing at $1,776 per ounce. This pushed S&P/TSX Global Gold Index higher by more than 11%. Traders speculated that this continued influx of liquidity into the economic system will eventually cause an increase in inflation. Gold has long been thought of as one of the best hedges against inflation that is available. Another factor that helped to push gold higher was the drop in the U.S. dollar, which saw the Canadian dollar end the month at $1.0166 USD, up from $1.0139 USD at the end of August. The value of commodities, which are generally priced in U.S. dollars, tend to rise when there is a drop in the value of the U.S. dollar, all other things being equal.

With its heavy weighting in materials, it is no surprise that the S&P/TSX Composite was one of the strongest performers, gaining 3.1% during the month. The S&P 500 was up by 2.3% while the MSCI EAFE Index gained 2.7%. Small caps outpaced their large cap brethren, with the BMO Canadian Small Cap Index rising 4.2%. This trend continued globally, with the Russell 2000 gaining 2.9% and the Dow Jones Global Mid Cap Index up by more than 3.1%.

Looking ahead, we remain cautious. While the ECB bond buying program has likely removed much of the risk of an outright collapse in the region, its debt crisis and economic picture are far from being in the clear. The region remains mired in a severe recession that is having a negative impact on global economic growth. Clearly more action needs to be taken to remedy the situation, and until that happens, considerable risk remains.

China and the emerging markets also find themselves mired deep in an economic slowdown. In China, growth is expected to slow to 7.8%, which is down considerably from the more than 10% pace we have become accustomed to. This is largely due to government action that is designed to help deflate the country’s massive property bubble. Because of this slowdown, global growth in general is being affected.

Closer to home, there is considerable uncertainty in the U.S. with the election dominating sentiment and worries over the “fiscal cliff” of tax increases and spending cuts looms large. Further adding to the concerns are worries that we may see a bigger slowdown than expected in corporate earnings in the coming weeks as many report their most recent results.

Considering the above, our investment outlook remains defensive. We continue to emphasis actively managed funds which invest in high quality companies. In the fixed income space, we are looking to funds that allow the managers the flexibility to invest in a wide range of strategies that will help to increase returns and manage risk in a flat to rising rate environment. With equities, we are focusing on actively managed, large cap focused funds that invested in well managed, high quality companies that generate strong cash flows. We are still avoiding Europe and China in the short term, however, in the coming months we may begin to look at some specific opportunities. Instead, we continue to favour the U.S. and Canada.

For the month of September, the best and worst performing funds (not including alternative strategy funds) were: