The second quarter of 2014 reported gains of 5.7% for the S&P/TSX and 5.2% for the S&P 500. This marks the sixth consecutive increasing quarter for the S&P 500, its longest run of gains since 1998. After falling at the beginning of Q2, US stocks rose despite trouble around the globe. Among the S&P 500, energy was by far the strongest group, doubling returns of most other sectors in the index. Against market expectations for higher rates, mid and long-term US Treasury yields fell, with the benchmark on 10-year Treasury note falling nearly 0.2% over the quarter to finish at 2.5%.
Focus was on the Federal Reserve during the Q2; the central bank has been scaling back its quantitative easing program since the beginning of 2014, further reducing its monthly bond purchase program each month over the last quarter. The next step will be a widely anticipated increase in short-term interest rates – but exactly when that will occur remains unclear. Much depends on the state of the labour market and the rate of inflation. Signs of inflation started to appear which alleviated worries of deflation. According to many economists, the economy seems positioned to accelerate in the upcoming months. Despite slow employment gains, all 8.7 million jobs lost in the recession of 2008 have now been replaced.
In Canada, the Bank of Canada is in no rush to raise rates. The BoC is still hoping for a more meaningful recovery in business investments and exports, and the fact that at this point it expects inflation to ease suggests that it is not very optimistic about a strong rebound in those drivers any time soon. When rates do start rising, the BoC will likely go more slowly. Along with the negative implication of higher rates on the economy, rising interest rates will act as a negative value for the Canadian dollar.
On another note, as investors braced for the possible imposition of broader economic and financial sanctions on Russia, outflows of foreign capital accelerated. From a longer term perspective, the crisis may be a positive development for Canada as it will accelerate attempts by the EU to reduce its dependency on Russian energy, thus opening the possibility for Canada to play an important role in this process.
European equities were supported by the European Central Bank’s announcement to stimulate growth and avoid the prospect of deflation. Although it did not start quantitative easing, the ECB cut its deposit rate to -.10%, meaning it will charge banks to keep cash at the central bank in hopes of encouraging them to lend it out instead. It also reduced its lending rates in a targeted longer-term refinancing plan to boost lending to small and medium-sized businesses.
The ECB’s stimulus actions, along with the improving US economy and signs of stabilization in China, have boosted confidence in the global economic outlook, and increased investors’ appetite for risk. With the threat of deflation subsided and despite geopolitical risks mounting, the overall sense is that the growth in developing economies is stabilizing and is likely to trump the downside risks.
All the best,
Anthony Ciccone, B.Comm, CHFC
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