KNOWLEDGE CENTRE

• Investors continue to favour defensive assets in the equity markets. 
• Global bond yields fall in response to growth concerns and eurozone woes. 
•  Economic indicators disappoint, but SEI remains optimistic in the longer-term.

The Dow Jones Industrial Average index was down (USD) 1.53% in May, while the S&P 500 Index fell (USD) 1.13% and the NASDAQ Composite Index declined (USD) 1.20%. The MSCI AC World Index fell by (USD) 2.15% as investors began to fret about disappointing economic data releases and as sovereign debt fears in the eurozone resurfaced. However, corporate earnings results continued to exceed expectations and, on the whole, sentiment remained generally buoyant.

The Barclays Capital Global Aggregate Bond Index declined (USD) 0.08% in May. Global government bonds and global corporate bonds recorded roughly equivalent losses, and high-yield bonds also struggled. Emerging-market debt was the one bright spot, and one of the only areas of the fixed-income market to gain in May.

Stocks

The S&P/TSX Composite Index was down 0.87% in May. On a global level, growth-orientated stocks outperformed value-orientated stocks. Small-company stocks marginally beat large-company stocks. This was particularly the case in Europe, where struggling banks dragged down large-company performance. Developed-market equities outperformed emerging-market equities.
Globally, defensive sectors like Health Care and Consumer Staples outperformed. The Energy sector lagged again in May as oil prices began to fall, partially in response to global growth fears. WTI Cushing crude oil prices dropped from (USD) $113.93 at the start of the period to (USD) $102.70 per barrel by the end of May. The Material, Industrial and Financial sectors also struggled.
The Chicago Board Options Exchange Volatility Index (VIX), a measure of implied volatility in the S&P 500 Index that is also known as the “fear index”, was largely unchanged in May, moving from 14.75 at the start of the period to 15.45 by the end.

Bonds

Weak economic data from around the globe helped push the Canadian bond market to its best month since August 2010, as the DEX Overall Index advanced by 1.54%. As concerns over the prospects for growth increased, global government bond yields in the developed world, including the U.S., Germany and the U.K., fell across maturities. However, the sovereign debt of Portugal, Ireland, Spain and Greece struggled. This was the result of the announcement of the terms of Portugal’s £70 billion bailout (financed by the European Union, the eurozone and the International Monetary Fund) and further country-specific credit rating agency downgrades. Moreover, the likelihood of a restructuring of Greek debt increased and served to further spook investors. As a result, yield spreads for peripheral European countries versus German debt continued to rise.

Although earnings reports and company balance sheets remained positive, investor demand for corporate bonds dipped somewhat in May. Within global corporate bonds, higher quality investment-grade debt was the most successful, and AAA-rated debt (AAA-rated are the highest; D rated are the lowest. Ratings below BBB are classified as non-investment grade, or junk, and are considered to be riskier) performed best. Japanese corporate bonds struggled in particular, as did the corporate debt of peripheral European countries. In contrast, U.S. debt held up well. Globally, bank debt struggled in particular.

While returns for global high-yield disappointed, U.S. high-yield debt continued its positive streak and yields fell. Those bonds with exposure in the Energy and Telecommunications sectors performed especially well, while Financials lagged. Mid-quality high-yield debt did best, with BB-rated bonds generating the strongest returns, while lower-quality, CCC- rated debt did worst.
Demand for emerging-market debt from new and existing investors continued in May, albeit at a slower pace than witnessed in 2010. As the developed world struggled to generate growth while fighting inflationary pressures, economic data for the emerging world remains supportive of growth. Gross domestic product (GDP) releases for China, along with other countries such as India and those in Latin America, have been positive. However, inflation in the emerging-markets remains a concern. This is particularly the case for countries like China, where inflation has risen at the fastest rate since 2008 and is currently running at more than 1% above target.

Economy

Economic data in Canada was generally positive in May. It was reported that Canada’s gross domestic product (GDP) expanded by 3.9% in the first quarter of 2011, close to economist’s forecasts of 4.0%. Statistics Canada stated that this was the result of inventory accumulation and an increase in business investment in machinery and equipment. Statistics Canada also reported that Canada’s account deficit shrank to $8.9 billion in the first quarter of 2011 from $10.3 billion in the previous quarter. Strong exports of energy products to the U.S. contributed to the decline.
The Canadian labour market continued to improve in May, as Statistics Canada reported that the economy added 22,300 jobs. Estimates called for an addition of 20,000 jobs. The country’s unemployment rate fell to a two-year low of 7.4%. Statistics Canada also noted that operating profits for Canadian companies were up 4.2% in the first quarter, driven largely by gains in the financial sector, manufacturing and the oil and gas industries.

Finally, Canada Mortgage and Housing Corp. reported that housing starts rose in May, as the seasonally adjusted annual rate moved to 183,600 units from 178,700 units in April. The increase was attributed to a pickup in multi-unit dwellings such as apartments and condos.

Due to a string of underwhelming economic releases in the U.S., May ended with concerns about both the economy and the employment picture. Consumers were most affected by higher gas prices, the downturn in the housing market, a slowdown in manufacturing and ongoing difficulties in the labour market.

During the month, the U.S. Department of Commerce reported that first-quarter gross domestic product (GDP) was unchanged from an earlier estimate, growing at a 1.8% pace. A deceleration in consumer spending due to surging energy costs contributed to the low number.

The National Association of Home Builders/Wells Fargo sentiment index showed that U.S. homebuilder confidence remained pessimistic in May. The index has maintained the same low level for six out of the past seven months.

U.S. manufacturing grew at a slower pace in May, as the Institute for Supply Management (ISM) Manufacturing Survey fell to 53.3 from 60.4 in April. The ISM Non-Manufacturing Survey’s May reading of 54.6 represented an improvement over April’s 52.8 number, as growth within the service industries increased for an eighteenth consecutive month. Readings above 50 indicate expansion in both surveys.

The U.S. Department of Labor reported that nonfarm payrolls increased by a mere 54,000 jobs in May, well below consensus estimates of 170,000. The U.S. unemployment rate ticked higher to 9.1% in May from 9% in April. As a result of May’s negative economic releases, U.S. consumer confidence, as measured by the Conference Board’s index, fell to 60.8 in May from a revised 66.0 in April.
It was announced in May that U.K. inflation, as measured by the Consumer Price Index, rose from 4.0% in March to 4.5% in April. This is 2.5% higher than the Bank of England’s target rate of 2.0%. Higher transport costs, particularly for air travel, along with rising tobacco and alcohol prices have been cited as contributors to the increase.

Despite inflationary concerns, the Bank of England’s Monetary Policy Committee voted to maintain U.K. interest rates at 0.5% again. It is likely that this cautious stance was driven by generally disappointing economic data and nervousness about the short-term economic outlook for the U.K in light of mediocre growth figures for the first quarter of 2011.

After rising by 5.2% in April, industry analysts warned that the U.K. Retail sector remained under pressure. This was reflected in May, as sales dipped again. Growth in the U.K. manufacturing sector (as measured by Markit/Chartered Institute of Purchasing and Supply U.K. manufacturing purchasing managers' index) also slowed. According to Halifax, house prices also fell. However, positive news came in the form of improved unemployment data, as unemployment in the U.K. fell to 7.7% in the quarter ending March 2011.

After raising eurozone interest rates for the first time in nearly three years in April, the European Central Bank left rates unchanged at 1.25% in May. It was, however, hinted that a further rise in July could be in the cards in response to inflation, which reached 2.7% during the month. Eurozone GDP was also confirmed at 0.8%, with growth led by core countries such as Germany.

The U.S. dollar gained against sterling, the euro and the Japanese yen in May, while the euro fell against most of the major currencies during the month. The U.S. dollar ended the period at $1.65 against sterling, $1.44 versus the euro and at 81.24 yen.

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