Financial markets had another choppy month to finish off a bumpy year that offered little to show for the trouble. Headlines such as a “weather related” U.S. economic slowdown, a possible “Grexit” from the eurozone, a decelerating Chinese economy and the continued free-fall in commodities rattled market sentiment from time to time this past year. While global growth has slowed, the U.S. economy continues to plod along with a tepid but steady 2% growth rate, a strong labour market at a pre-recession unemployment rate of 5% and a moderate, albeit, below target inflation level. One major obstacle, the long-anticipated Fed rate hike, was recently handled with aplomb – thus removing, for now, the uncertain effects of concluding the Fed’s unprecedented zero interest rate policy (ZIRP). Despite a positive U.S. outlook and contained impact of the Fed’s rate move, Canadian investors, with globally diversified portfolios, owe the lion’s share of their gains from the currency effects of a falling loonie.
The month’s first half saw equity investors in a dour mood as financial markets reeled from renewed concerns over global growth, another step down for commodity prices and a miserly ECB response to its economic doldrums. In the U.S., demonstrative momentum in the labour market was eclipsed by November’s disappointing ISM Manufacturing Index reading of 48.6 (a three year low) and an expected decline in U.S. real exports by 2.4% – widening the trade deficit by $1.4B to $44B in October. The gloomy tone was echoed across the pond as the ECB’s Christmas gift of a 10 basis point cut to the lending rate and a six month extension of its QE program fell short of the largess expected by investors. Crude oil added to the darkness as it hit a six year low on OPEC’s announcement to leave oil production targets unchanged – tacitly abandoning its past record of controlling crude prices. The poor outlook for oil added to contagion concerns in the high yield credit market as high profile oil players such as Kinder Morgan and Encana uncharitably slashed their dividend by 75% and 79% respectively. In Canada, expectations were held in check despite third quarter’s GDP ticking in at 2.3% annualized and the BoC holding pat on lending rates, as analysts expect a deceleration in GDP due to continued weakness in the resource sectors. Adding to the cold bath was a 1.5% decline in real exports and the unemployment rate moving up to 7.1% on the back of 36,000 lost jobs in November. By the end of the second week, oil prices fell a drastic 15% in a fortnight to US $35 bbl. Canadian and U.S. equities were down 5% and 3% respectively. Europe was also down 1% after accounting for an unexpected rise in the Euro – the loonie also falling 3% and 5% against the greenback and Euro respectively.
The month’s second half finally vindicated interest-rate forecasters as the U.S. Fed announced its first rate hike in nine years. Equities staged a rally in the days leading up to the announcement, with some profit-taking shortly thereafter. Investors appeared to interpret the Fed’s action as a vote of confidence in the U.S. economy. The conspicuous announcement was further distinguished for not only bringing rates off a historic floor of zero percent, but also, with all Fed board members voting unanimously in favour of the modest hike. The possibility of market disruption from this decision was averted with bond markets taking the news in stride as Fed Governor Yellen stressed that further rate hikes would be “gradual” and driven by labour market and inflationary considerations – the momentum of both not a certainty . The Fed’s trepid move came off without a hitch as short-term interest rates moved as expected despite the current environment of excess reserves while long-term rates were largely unaffected. Treasury prices fell as yields rose prior to the Fed’s announcement. The investment-grade and high-yield corporate bond market’s reaction to the rate hike was muted. European equities rallied following the Fed’s announcement but pulled back as the usual concerns about underlying weakness in the global economy affected market sentiment. For the last two trading weeks of the year, Canadian and European equities were down 1% while U.S. markets were off 0.5%.
By the end of the month, Canada’s TSX lost 3% with ten sectors in the red with energy greatly affecting at -8%. The S&P 500 slipped -1.5% while the EAFE indices declined 1.3% – both of which benefited from a 3.7% monthly drop to the loonie – bringing them both into positive territory (+2.2%). The U.S broad-based bond index vacillated in a 0.7% trading range only to finish down a gentle 0.3%, while Canadian bond investors enjoyed the effects of monetary policy divergence with a 1.1% gain their index.