Global equity markets posted gains in May, with the U.S. leading the charge higher on improving economic data. For the seventh month in a row, the index was in positive territory. The S&P 500 rose by 2.3% in U.S. dollar terms, but when the affect of a surging U.S. dollar is taken into account, the gain was 5.3% in Canadian dollar terms.
Fueling the gains was news that housing sales were continuing their rebound, combined with better than expected manufacturing numbers, and surging consumer confidence. This also helped to boost the U.S. dollar, which moved from just over parity with the Canadian dollar in April, to end May at $1.0339.
Europe was stronger, with gains in France, Germany and the U.K. Still, this wasn’t enough to keep the MSCI EAFE Index in the black, as Asian markets continued to drop. Japan, which has been on a tear of late also lagged, as investors expressed disappointment with the government’s stimulus package. For the month, the MSCI EAFE Index was off by 2.3%, but was modestly positive in Canadian dollar terms once the currency impact was considered.
Closer to home, the S&P/TSX Composite Index rose by 1.8%. Materials, at least temporarily halted their slide, gaining 3.2% in the month. Healthcare, industrials and consumer names were also higher. The interest rate sensitive sectors of real estate and utilities were lower, as bond yields moved sharply higher across the board on rumours that the U.S. Federal Reserve would be ending their massive quantitative easing plans sooner than many had expected.
Yields on the benchmark ten year government bonds rose on these rumblings, with the Canadian ten year moving from 1.69% to 2.06%, and the U.S. ten year rose to 2.16% from 1.87%. This caused a selloff in the bond markets, with the DEX Universe Bond Index falling by more than 1.5%. Long bonds and real return bonds, with their longer durations were hit the hardest, while shorter duration and corporate and high yield bonds held up relatively well.
While the timing of this bump in yields may have been a bit of a surprise, the fact that they did move higher shouldn’t be. Still, even if yields move higher, we don’t expect that the U.S. Federal Reserve or the Bank of Canada will move to raise rates anytime soon. While the economic fundamentals are improving in the U.S., they are stagnating in Canada, leaving the Bank of Canada little room to move. With this backdrop, we expect some continued short term volatility in the fixed income markets, and recommend that investors shorten the duration of their fixed income holdings and move out into the corporate bond space. The higher yields offered by corporate bonds will provide better downside protection when yields move.
We continue to favour equities, with the U.S. being our preferred region. Economic activity is improving and valuations are still reasonable. Those with higher risk tolerances may want to consider adding some European exposure to their portfolios, but we do expect the region to remain very volatile. We would suggest a high quality, actively managed global equity fund as a great way to access the space. Asia, particularly China is expected to remain very volatile, as questions continue to mount about the reliability of the economic statistics and the true level of growth in the country.
We believe that conditions remain quite challenging for investors and in this environment, we continue to favour actively managed funds over the indices.