Historically, October has been one of the most volatile months for equity markets, and this year looked to be no different. The stage was set for a bumpy ride as continuing uncertainty over the prospect of the U.S. Federal Reserve slowing the pace of its bond buying program weighed on investors. Adding fuel to this potential flame was the high stakes game of chicken playing out between the Republicans and Democrats that led to a 16 day shutdown of the U.S. government and raised the possibility that the U.S. could default on its debt.
Despite these looming threats, investors largely shrugged them off as inconsequential as global equity and bond markets rallied higher. The S&P/TSX Composite Index gained 4.7%, while the S&P 500 was up 4.6% and the MSCI EAFE Index gained 3.4%. The Canadian dollar fell from $0.9723 U.S. to $0.9589, which helped to boost the returns for Canadian investors.
Liquidity has been one of the reasons that markets have rallied, and there was much positive news on that front in October. The Fed once again held their bond buying program steady, while many global central banks kept their monetary policy very accommodative. Markets also rallied on news that U.S. President Barrack Obama would name Janet Yellen as Ben Bernanke’s successor as the Chair of the U.S. Federal Reserve. Ms. Yellen has been quite dovish in her views on monetary policy, and her appointment makes it very likely that it will be at least early 2014 before there is any serious talk of tapering.
With rates likely on hold for the near term, fixed income markets rallied, led by high yield and emerging market bonds. Within the investment grade universe, it was corporate bonds outpacing government bonds.
As we enter the final quarter of the year, my investment outlook favours actively managed equities over fixed income. Looking at the employment and inflation outlook, it is now looking as though it will be at least early 2014 before the Fed can begin to curtail their bond buying. While that provides the potential for a short term rally in bonds, there is still a higher probability that we will see bonds remain flat or fall over the medium to long term.
Within equities, the recent rally in European equities has left valuations looking a bit rich, giving the potential for a pullback in the near to medium term. I certainly don’t expect anything close to what we saw in 2008, but some pullback is likely. For longer term investors, any such pullback would be a good opportunity to add to your European holdings.
I am favouring North American equities over Europe or Asia. In the U.S., we are starting to see signs that corporate profit growth will slow in 2014. If growth merely moderates, valuations look reasonable and modest gains are expected. Obviously, if growth slows significantly more than expected, a selloff is probable. Another concern in the U.S. is the uncertainty that could be created as partisan bickering gets in the way of a negotiated settlement to both the U.S. budget situation and the debt ceiling. Should another government shutdown happen in the New Year, equities are likely to be hit.
In Canada, I continue to favour those funds that look much different than the S&P/TSX Composite Index. These funds offer more diversified exposure to Canadian equities and as a result, are less risky, at least in my opinion. A concern with Canadian equities is the potential headwind that could result from commodity prices. With inflation on the backburner, the outlook for gold remains muted. On the other hand, oil and gas look to be on an upswing, as global economic activity continues to improve.