Global equity markets rallied higher for the third month in a row, with the U.S. leading the way with a broad based rally. The S&P 500 gained more than 3% in U.S. dollar terms on an improving global economy. Factor in a weakening Canadian dollar and the gains were even higher for Canadian investors, with the S&P 500 returning nearly 5% in Canadian dollar terms
European markets were also higher, with the MSCI Europe Index gaining 1.2%. Economic numbers reinforced that Europe has turned the corner and is on the rebound. Still, risks, namely the debt levels and the modestly slow pace of growth continue to hang over the markets.
With announcements that the Chinese government would be bringing in a series of economic and social reforms, the outlook for the global economy got a little boost. In reaction, investors took Chinese funds higher, which were the best performing fund category in the month. Still, the broader Asian region was lower, muting overall gains in the MSCI EAFE, which would have been in negative territory, were it not for the Canadian dollar falling from $0.9589 US to $0.9435 US during the month.
Investors were still worried over the prospect of the U.S. Federal Reserve slowing the pace of their $85 billion a month bond buying program, but those fears were lessened with the confirmation that Janet Yellen, a proponent of the easing program, had been appointed Ben Bernanke’s successor as the Chairman of the Federal Reserve. Despite this, the yield on the U.S. ten year bond rose from 2.57% to 2.75%, pushing bond prices lower.
Gold continued its descent, falling another 5.4% as the economic data indicate that the threat of inflation remains muted for the time being. Factor in a relatively calm geopolitical environment and the outlook for gold, at least in the near term, looks pretty grim.
One of my bigger worries was that there would be another showdown in the U.S. over the budget and debt ceiling, as the mid-January deadline approached. By all accounts it looks as though they all learned a lesson from their October shutdown, and have reached a compromise deal that funds the government for the next couple years. While not perfect, it takes some near term uncertainty off the table.
This, combined with the economic data, namely jobs and consumer spending, that show the U.S. economic recover is picking up steam, increase the likelihood that the Fed will begin tapering their bond purchases later this month. While not a sure thing, the probability is a lot higher with the budget deal than without it.
Should a tapering be announced next week, expect a sharp pullback in the markets as traders adjust to the new reality that includes less government intervention in the capital markets. However, once everyone gets over the initial shock, they can begin to focus on the stronger economic fundamentals which paint a favourable picture for global growth, and ultimately equities over the next little while.
With the passing of the budget deal, I have become slightly more bearish on bonds. Previously I thought that there was some room for yields to ease slightly, but I have since changed my view on that. Now, I believe that there is renewed, and sustained pressure on them to rise. This does not bode well for most fixed income investments. In this environment I favour short duration over long, and corporate, high yield and floating rate over governments.
With equities, I continue to favour U.S. equities, but do expect a shorter term pullback. I am neutral on Canadian equities, and am mildly negative on Europe in the near term.
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.