The financial markets are constantly evolving and the outlook can change very quickly from one month to the next. You may be wondering why the market value of your portfolio fell in April when, for more than one year now, each new statement showed continued strong performance by the markets and your portfolio. To shed some light on this, we thought we would give you more information on current market trends.
2015: A return to volatility
The financial markets have been volatile since mid-March. In fact, part of the first-quarter returns obtained by the balanced portfolio were lost in April and early May. The factors behind the strong early-year performance suddenly reversed course. This change reduced some of the gains of the balanced portfolio, despite the solid performance of U.S. stocks, which even hit new highs. So why such a result despite the gains on the S&P 500?
In January, against all expectations, interest rates fell sharply, driving up bond prices. The bond market performed exceptionally well early in the year. U.S. economic growth disappointed again, and harsh winter weather curtailed consumer spending, as in the winter of 2014. A prolonged strike at the port of Los Angeles also aggravated the situation.
Bond market movements
At the same time, the European Central Bank (ECB) began a massive quantitative easing program by buying a huge amount of sovereign European bonds. Although expected, these interventions on the bond market triggered a decline in yields on German, French, Italian, Spanish and other sovereign bonds to unprecedented levels. For example, the yield on 10-year German bonds fell to almost 0%, versus 2% in late 20131.
This extraordinary situation gave rise to the second main reason for the strong first-quarter performance. The yield differential between U.S. and European bonds widened considerably, creating a strong incentive to hold U.S. bonds. The flow of capital into U.S. Treasuries drove up the value of the U.S. dollar versus the euro and the Canadian dollar, thereby improving the return on U.S. equities.
At the same time, the strength of the U.S. dollar caused oil prices to drop, forcing the Bank of Canada to unexpectedly cut its key rate to protect against the negative impact of lower oil prices on the economy. This decision accentuated the loonie’s fall versus the greenback.
Oil, euro and interest rates decline
The decline in oil prices, the euro and interest rates in the first quarter revitalized the European economy. Investors are now more confident about the outlook for the euro zone. In addition, the fall in European rates to levels deemed unsustainable prompted investors to take profits.
On the other side of the Atlantic, the economic outlook weakened and investor expectations changed concerning U.S. monetary policy tightening, which has now been put off until the fall. Consequently, the U.S. dollar fell by more than 5% from first-quarter levels, triggering a rise in oil prices from $45 to $60 a barrel, which in turn altered the outlook for inflation and interest rates.
Ultimately, the decline in the U.S. dollar erased the first-quarter exchange rate gains for Canadian investors, and the upturn in rates negatively impacted bond returns.
Outlook for the next few months
We believe the risk of recession is low. In fact, global economic growth should pick up in the second half, since U.S. economic weakness is due to temporary factors. Better synchronization of developed economies augurs well for stock market performance. In addition, the recent rise in rates will be limited. Economies are fragile and could not withstand a sharp rise in borrowing costs.
Should you have any questions about the current situation or your portfolio, don’t hesitate to contact your Wealth Management Advisor.
François Landry, CFA
Senior Vice-President and Chief Investment Officer
The information and data provided in this document, including those provided by third parties, were considered accurate at the time of their printing and were obtained from sources that we deemed reliable. This information and data are provided for information purposes only. No representation or warranty, explicit or implicit, is made as to the accuracy, quality or completeness of this information and data. The purpose of this document is to provide general information and in no case should it be construed as offering investment, financial, tax, accounting or legal advice. In no case does this document recommend the purchase or sale of any security whatsoever. For any questions, please contact your Wealth Management Advisor.
1 Source: Bloomberg