The S&P 500 continued its advance in the third quarter reaching record highs in early August. Strong manufacturing data and better than expected second quarter earnings reports helped propel the S&P 500 through the 1,700 level for the first time ever. The earnings growth rate for the index in the second quarter of +2.1% year over year was considerably better than forecasts and marked the third consecutive quarter of positive earnings growth. The market’s focus then shifted to rising bond yields as better economic data spurred concerns that the U.S. Federal Reserve (“the Fed”) would reduce (“taper”) its $85-billion-per-month bond buying program in September, which would be sooner than market expectations, The bond buying program is aimed at keeping borrowing costs down and fueling the economy. News about chemical weapons attacks against civilians in Syria onAugust 21st added to the geopolitical nervousness in the markets as the likelihood of a retaliatory strike against Syrian President Bashar al-Assad’s forces grew. Gold spiked up through $1,400 per ounce and oil rose over $110 per barrel, while the S&P 500 pulled back almost 5% from its early August highs.

…

The S&P 500 continued its advance through April and May hitting an all time high on May 22nd of 1,687, before pulling back almost 8% to the June low of 1,560 and eventually closing at 1,606 on June 30th. The second quarter started out on a positive note driven by better than expected first quarter earnings. In fact, 70% of companies reporting first quarter earnings inApril and May beat expectations with the blended earnings growth rate for the quarter coming in at +3.3% as compared to -0.7% estimated at March 31st . All ten sectors of the S&P 500 showed earnings growth during the first quarter.The positive market momentum inApril and most of May was also supported by strong economic data including better than expected auto sales, improving jobless claims and overall much stronger consumer confidence. On May 22nd, Fed Chairman Ben Bernanke indicated in his first testimony before Congress since February, that while the economy has shifted to a more sustainable growth trajectory, the employment picture still remains weak overall.This seemed to suggest status quo in terms of quantitative easing. However, the minutes from the Federal Reserve’s policy meeting released that afternoon, indicated some Fed members were in favour of tapering the central bank’s $85-billion-per-month bond-buying stimulus program as early as June. This mixed message resulted in the sell-off in equities and an increase in bond yields. Weaker manufacturing data out of China and concern about a possible credit crunch also weighed on markets globally. The June 19 Fed meeting caused a further downdraft for the S&P 500 as the Fed confirmed it may moderate its pace of bond purchases towards the end of the year and completely stop by mid-2014. The total return for the S&P 500 in the second quarter was +2.9% in US$ or +6.5% in C$ as a result of a weaker Canadian dollar.

…

The S&P 500 started 2013 with the biggest one day gain in more than a year as investors welcomed a budget agreement that averted the “fiscal cliff”.The strong performance continued right through the first quarter. Not even concerns over the Italian election results, in which Italy has not yet formed a coalition government or costs associated with quantitative easing which have raised worries that the Fed stimulus could end sooner than expected, were enough to curb market enthusiasm through the end of February. In March, the focus shifted back to the Eurozone as the European Central Bank (ECB), European Commission, International Monetary Fund (IMF) and the Cypriot Parliament worked to finalize a €10 billion Cyprus bank bailout that would see shareholders, creditors and uninsured deposit holders cover much of the cost. The main concern in the market was the possibility that this may be considered a template for future bailouts, which could derail the fragile and nascent Eurozone recovery. None of this in itself was enough to slow the market momentum as the total return forthe S&P 500 in the first quarter was 10.6% in US $ or 13.0% in C$ as a result of a weaker Canadian dollar in the quarter. The first quarter was all about fund flows as liquidity poured into U.S. equities at about the fastest rate we have seen since 2007. Positive housing and jobs data in recent months have only added fuel and not even the sequestration cuts that began in March have had much impact on market momentum. The S&P 500 closed the quarter at its all time high surpassing its October 2007 peak. In contrast to the S&P500, the total return for the S&P/TSX was 3.3% or about one quarter the performance of the S&P 500. Performance in Canada continues to remain hindered by the underperformance of the heavily weighted materials index. A combination of poor operating performance in mining and disappointing commodity pricing has held back the Canadian market year to date. During the quarter, pricing pressure continued to mount on the price of gold and copper with gold closing at US$1598.75 per ounce, down 4.6% in the quarter and copper, down 4.9% at US$3.42 per pound. Below-normal temperatures across most of the United States helped oil and natural gas prices as oil closed up 4.4% at US$97.23 per barrel while natural gas increased 20.0% to close at a 52-week high US$4.02 per mcf.

…

The S&P 500 in the fourth quarter was muted compared to the strong third quarter where it hit its highest level in five years. The total return for the S&P 500 in the fourth quarter was -0.38% in US$ or 0.76% in C$ as a result of a weaker Canadian dollar in the quarter. The TSX managed to fare a little better with a total return of 1.72% during the fourth quarter. While the S&P 500 began October trading near record highs, there were concerns about the impact Hurricane Sandy would have on earnings and it was reflected in downward pressure on stocks in late October. This was followed by a sharp selloff post the U.S. Presidential election in November as news about the fiscal cliff dominated the headlines. The market was concerned because if no budget deal was reached by year end, it would result in automatic spending cuts and higher taxes in 2013.Although political brinkmanship ended up pushing the U.S. economy over the cliff, at least for a few hours, the extraordinary New Year’s Day compromise was a welcome relief for the markets going into 2013. Both political parties seemed to save face as the agreement raised taxes on the wealthiest 2% of Americans but permanently codified all tax brackets for everyone else. This one source of uncertainty held back consumers and businesses in 2012. The markets celebrated the economy avoiding a major dip in GDP by advancing the S&P 500 with its biggest one day advance in over a year during the first trading session of 2013. However, the issue is far from being fully resolved, as the deal focused only on the revenue side of the equation and has yet to address spending, the debt ceiling and the continuing resolution of the fiscal year 2013 budget. One economist referred to these issues as the three gorges that must be dealt with during the first quarter of 2013.

…

After a weak second quarter that saw the S&P 500 ($U.S.) fall 2.8% and the TSX down 5.7%, both U.S. and Canadian equity markets rallied in the third quarter on stronger than expected second quarter earnings and the prospects that central bankers would provide more monetary stimuli to help bail out stagnating global economies. On July 26th ,the market seemed to get exactly what it wanted when the European Central Bank president, Mario Draghi, said he would do whatever was needed to keep the continent’s monetary union in place to preserve the Euro. Then on September 13th, in a widely anticipated move, the Fed announced that it would purchase $40 billion a month in mortgage-backed securities. Unlike previous rounds of quantitative easing, Mr.Bernanke did not set a limit on how much the Fed would spend and instead tied the timeline of commitment to improving labour markets. The Fed also extended its commitment to keep interestrates “exceptionally low” to at least mid-2015 from late 2014. While the Fed response in general was widely anticipated, what was surprising was the openended nature of this third round of quantitative easing.

…

After a strong start to the first quarter of 2012, in the second quarter investors were once again reminded of the macro risk factors facing the global economy and the European sovereign-debt crisis in particular.April returns were more or less flat in both Canada and the U.S. equity markets as Q1 earnings reports were generally better than consensus expectations.Actual Q1 earnings reports showed +7.3% year over year growth compared to negative expected growth for consensus earnings estimates. However, May was dominated by a series of unfavourable economic reports that supported the old adage: “sell in May and go away”. Between weaker than expected data on European private sector business activity, Chinese industrial production and U.S. jobs, both the U.S and Canadian stock markets lost over 6% in May alone. This culminated with the S&P 500 testing the lows of its 200 day moving average on June 4th but quickly snapping back

It was only a few short months ago when the Eurozone was in the midst of a liquidity crisis that felt like it was about to morph into a global contagion. And despite the initial widespread skepticism around the efficacy of the Long Term Refinancing Operation (LTRO), it clearly provided the necessary liquidity for the European banking system. Once those fears subsided, the market redirected its concerns from the European sovereign debt crisis to a number of economic indicators in the U.S., the world’s largest economy.

…

The ECB Joins “Club Fed” (through the Backdoor)

Despite its constant protestations that it would not embark on a program of Quantitative Easing, this week the ECB has in effect started doing exactly that (well, almost exactly) in an attempt to keep the European debt crisis from spiraling out of control. The official name of the program is the Long Term Refinancing Operation (LTRO) and its official purpose is to relieve liquidity (short term funding) constraints for European banks. Officially, the ECB is definitely NOT monetizing sovereign debt, but in practice (in our view) the LTRO is a backdoor way to accomplish exactly that goal. When trying to figure out the true intentions of a central bank, the golden rule is “Don’t listen to what they say – just watch what they do”. So in that spirit, let’s ignore anything the ECB has said and instead take a look at what they are actually doing.

…

Mission Impossible

The month of September was another month of elevated volatility for global financial markets as credit, currencies, stocks and commodities all reacted wildly to rampant speculation regarding the eventual course of action to be taken in Europe. The Canadian equity market took it on the chin, falling 9% last month as broad weakness in commodities dragged the index lower. Both oil and gold dropped over 11% during the month, driven by fears of a global economic slowdown and the closing of speculative long positions. Equity markets south of the border fared better as the safe haven status of the U.S. created global buying interest in their bonds, stocks and currency. The S&P 500 declined over 7% last month in U.S. dollars, but this was almost entirely offset by a 7% strengthening in the U.S. dollar relative to the Loonie. Not surprisingly, the euro also declined 7%, but remarkably, is actually higher year to date relative to the U.S. dollar by about 3%. Government bond yields in the U.S. and Canada plummeted to new lows,reflecting heightened fears over a new global banking crisis. The 10 year U.S. Treasury fell well below 2%, yielding just 1.8% at one point last month. Corporate bonds fared less well as spreads widened reflecting the dramatic move lower in government bond yields and heightened fears over credit risk from a potential double dip recession.

Fear of Fear Itself

“The only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.”
– Franklin D. Roosevelt from his 1933 Inaugural Address

Almost eighty years ago, a newly elected President of the United States, Franklin Delano Roosevelt, took the stage to give his Inaugural Address. The nation was just over 3 years removed from an unprecedented (at that time) stock market and banking system collapse, millions of Americans were unemployed, a precipitous decline in housing had vaporized the wealth of families, foreclosures had skyrocketed and business confidence evaporated. Federal, state and local budgets were under immense pressure as tax revenue declined and markets had lost trust in the currency. Sound familiar? To be sure, the situation then was much more difficult than what we face today. Poor policy choices by the previous Hoover administration are widely believed to have exacerbated an already very bad situation. By the time FDR took office in 1933, the U.S. economy had suffered three straight years of cascading economic decline with real GDP down by 25% over that period. There was an overwhelming malaise hanging over virtually everyone’s expectations for the future. It appeared hopeless.

…