Market Commentary June 2012

After a relatively tame first-quarter, volatility returned to the global equity markets with a vengeance, whipsawing stocks with a ferocity that was reminiscent of 2008. Despite a modest rally in June, the S&P/TSX Composite Index still lost 5.67% on the quarter. Global markets seemed to hold up a little better, with the S&P 500 shedding 1.0% and the MSCI EAFE Index dropping 5.0% during the quarter. Not surprisingly, fixed income fared well, gaining 2.2% as investors flocked to bonds on their safe haven appeal.

Many of the issues that investors had ignored during the first quarter, namely the European debt crisis, the slowdown in China, and the lackluster pace of the U.S. recovery, became the focus of their attention. In Europe, Greece was again at the forefront, as investors were sent back to the polls after coalition talks failed to result in a government, after the May elections showed no clear-cut winner. In the lead up to the election, many had feared that the anti-austerity movement had gained some widespread popularity, resulting in one of their parties winning the election. Fortunately, that did not happen, with the New Democracy Party, the main center-right party in the country winning the most seats.

The same cannot be said in France, where reigning President Nicolas Sarkozy lost the country’s election to socialist Francois Hollande. In the run-up to the vote, Mr. Hollande had made many promises about overturning many of the recently implemented austerity measures. Since his victory, he has boosted taxes on the rich and has vowed to create thousands of public sector jobs and increase government spending. In Spain, banks continued to struggle despite receiving a ballot from the government. Worries remained that the stability of the banking system was in jeopardy. Tthe euro zone has been pushed into a recession, which has negatively affected global economic growth.

In particular, China continued to show signs of a slowdown as demand at home faltered, compounding the issues brought on by Europe. Officials estimated that the GDP growth for 2012 would come in at 7.5%, the lowest level since 1990. The impact of the slowdown has been felt around the world, as the demand for commodities has been reduced dramatically. In Canada, we have been particularly hard hit given that the majority of our equity market is concentrated in the materials and energy sectors.

As we enter the second half of the year, we expect more of the same. Many of the issues that have been responsible for the elevated levels of volatility remain firmly entrenched. Europe continues to plod along making only minor progress on its debt crisis. This will continue to weigh on global economic growth. China’s economy continues to show signs of a slowdown, and recent data suggests this slowdown may be greater than originally forecast. This will continue to put pressure on commodities, which will continue to drag the Canadian equity market. In the US, the economy is showing signs of recovery, but with the headwinds resulting from a global economic slowdown, growth is expected to moderate in the second half of the year.

Our expectation is that interest rates and Canada and in the U.S. will remain on hold until at least early 2013. We expect that market volatility will remain high. Given this, we continue to focus on quality, both in equities and fixed income. For equities, we continue to favor North American focused funds and prefer those that invest in well managed, attractively valued, dividend paying companies.

For fixed income, we also continue to emphasize quality. With interest rates expected to remain on hold for the near term, we are favoring actively managed funds which invest in a mix of government and high-quality corporate bonds. These types of funds will continue to provide stability in times of volatility, yet will provide some level of downside protection when rates finally do begin to move higher. We also like funds which have a duration that is lower than the benchmark.

While market volatility may tempt many investors to overweight fixed income in a portfolio, we would suggest that investors strongly avoid this. While we don’t envision rates moving higher anytime soon, the risk reward profile of fixed income is heavily weighted towards the downside. Equities, while volatile, appear to be fairly valued, and provide strong upside for investors who can stomach the volatility, and who have a long-term time horizon. We are not suggesting that investors abandoned fixed income. On the contrary, we are suggesting that investors exercise caution within their fixed income holdings, and are not overly exposed to the potential risks.

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