KNOWLEDGE CENTRE

Knowledge Centre Archive

Aug
18
2011

July 2011 Market Update

By SEI Investment Management Unit

  • Investors favoured defensive assets in the equity markets.
  • Global bond yields fell in response to growth concerns and eurozone debt fears.
  • Economic indicators generally disappointed, but SEI remains optimistic in the longer-term.

Global equity and bond markets experienced a volatile July. The markets witnessed a general flight-to-safety, with investors shying away from risk in favour of defensive assets. In this environment, equities in general sold off, and fixed income—particularly government bonds—benefited. Market sentiment was driven by fears that the global economy could be pushed back into recession. Continued problems in the eurozone and ongoing U.S. debt issues along with weak economic data releases fuelled concerns for the month.

Economic Recap

Troubles in the eurozone again made headlines in July. Results of the annual European bank stress tests, which are designed to show how banks would cope if there was another financial crisis, had a limited impact in terms of easing negative market sentiment. Despite largely positive results—only nine of the 91 banks under scrutiny failed—concerns that the test parameters were not strict enough muted the good news.

In an effort to stem the panic surrounding the eurozone’s sovereign debt crisis, another, wider-ranging bailout package was agreed on 21 July. The deal largely pertained to Greece, but also granted the European Financial Stability Fund (EFSF) permission to buy Spanish and Italian bonds in order to help provide credit to these countries. Under the terms of the new agreement, Greece is to receive a further €109 billion and, along with Ireland and Portugal, will be allowed to reduce repayment levels on existing loans and extend repayment deadlines. At the same time, private sector companies were encouraged to offer Greece more flexible repayment options on its debt.

Adding to investor unease was the ongoing, and by month-end still unfinished, U.S. debt ceiling debate. The debt ceiling reflects the maximum amount of money that the U.S. government is allowed to borrow. Once the limit is reached, the government cannot borrow any more money and will fail to pay its bills, opening up the potential for the country to default on its debt obligations. Despite market expectations for a resolution prior to the 2 August deadline—the point at which the nation would reach the $14.3 trillion debt limit—political wrangling and the threat of a credit rating downgrade (whereby longer-term U.S. debt would lose its prized AAA status, which represents the safest debt classification) created a degree of uncertainty and helped to fuel the flight-to-safety witnessed during the month.

Weak economic data releases further rattled investors. Second quarter gross domestic product figures released in July were disappointing, with U.S. and U.K growth figures coming in lower than expected. Other economic indicators also suggested that the global economy was struggling. For example, the number of jobless in the U.S. and the U.K. remained stubbornly high. Eurozone unemployment data was also troubling, particularly in Spain, where 21% of the population is out of work.

The employment story was different in Canada, however, as the economy added jobs for a fourth consecutive month in July. Statistics Canada reported that employment rose by 7,100 jobs, and the country’s unemployment rate dropped to 7.2% from 7.4% in June. The decrease in the unemployment rate was attributed to fewer workers participating in the labour market. Canada also received positive news on the housing front, as Canada Mortgage and Housing Corp. reported that housing starts rose by 4.3% in July. The gain was attributed to heavy activity in multiple-housing units such as condominiums, townhouses and semi-detached homes.

Manufacturing indices in the U.S., Canada, the U.K., the eurozone and China fell. Purchasing activity in the Canadian economy posted a significant decline in July, as The Ivey Purchasing Managers Index decreased to a seasonally adjusted 45.4 from 68.2 in June. A reading below 50 indicates contraction. The U.S. Purchasing Managers Index (PMI) recorded its lowest reading in over a year in July, but was still above 50, the expansion level. China’s PMI hit its lowest level in more than two years.

Inflation globally remained elevated and, with the exception of the European Central Bank, which raised rates again at the start of the month, most central banks continued to maintain interest rates at historic lows to help stimulate growth. The Bank of Canada announced that it would keep its key interest rate at 1.0%, and did nothing to suggest that it would be raising rates in the near future. Analysts believe that a rate hike will take place in 2012.

Market Impact

With the increase in market volatility, all fixed income was positive during the month, as bonds were favoured over equities. Reflecting this flight-to-safety, global government bonds performed best. However, corporate debt also did well, while riskier fixed income—high-yield and emerging-market debt—lagged in comparison. Within government bonds, yields in general fell as demand increased. Bucking this trend was the government debt of struggling European countries, namely Spain and Italy, where yields rose as demand dropped. This was driven by concerns that the economic crisis could spread to these countries. Spain and Italy are much larger economies than any of the other troubled European countries (Greece, Portugal and Ireland) that already have required financial aid. Should Spain or Italy need a bailout, there is currently not enough money in the EFSF to fund it. However, after struggling for much of July, Greek debt rallied toward the end of the month, when sentiment was temporarily buoyed by the bailout announcement.

Equity markets experienced the brunt of market uncertainty in July and declined almost across the board. In a month in which most countries experienced falls, eurozone nations struggled the most. Spanish and Italian equities were particularly hard-hit. Globally, sectors that tend to do well when confidence is high and economic growth is anticipated, known as pro-cyclical sectors, sold off throughout July. The Information Technology and Energy sectors were the only exceptions to this rule, with the former benefiting from strong corporate earnings results from companies within the sector. Energy held up due to strong, but stabilizing, oil prices. The Industrials and Financials sectors lagged notably, the latter largely because of worries about banks’ exposure to eurozone government debt.

The Numbers

  • The S&P/TSX Composite Index returned CDN -2.70%.
  • The DEX Universe Bond Index advanced by CDN 2.10%.
  • The Dow Jones Industrial Average index returned USD -2.05%.
  • The S&P 500 Index fell by USD 2.03%.
  • The NASDAQ Composite Index returned USD -0.57%
  • The MSCI AC World Index fell by USD 1.63%.
  • The Barclays Capital Global Aggregate Index gained USD 2.06%.
  • The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index,” increased from 16.52 to 25.25 during the month.
  • WTI Cushing crude oil prices, a key indicator of movements in the oil market, remained largely unchanged from USD $95.42 a barrel at the end of June to USD $95.70 by 29 July.
  • The euro weakened against most currencies in July and investors expressed a preference for the Swiss franc, which is traditionally viewed as a safe haven in times of financial turmoil. The U.S. dollar gained against the euro, but fell against other major currencies. The U.S. dollar ended the period at $1.64 against sterling, $1.44 versus the euro and at 77.19 yen.

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