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• Ongoing eurozone troubles and the failure of the U.S. Super Committee undercut the optimism witnessed at the end of October.
• Equity and fixed income markets declined, with risky assets among the weakest performers.
• Losses were partially offset by month end as news of intended joint central bank action buoyed sentiment.

Events in the eurozone and the U.S. resulted in a volatile month for global investments. Stock and bond markets generally witnessed declines in November, although some losses were recouped in the final days of the month. This late-month rally was driven by positive reactions to the announcement of combined action on behalf of some of the world’s leading central banks to help ease the spread of the sovereign debt crisis in Europe.

Economic Backdrop

Political change driven by troubles in the eurozone dominated the headlines in early November. After failing to secure the confidence of his cabinet, the Greek prime minister resigned, followed swiftly by the departure of the Italian prime minister. However, new leadership in two of the region’s struggling economies, the lowering of interest rates in the eurozone and continued bond purchases by the European Central Bank failed to fully calm the markets.

November witnessed multiple credit rating agency downgrades (credit rating agencies rate bonds based on the ability of the issuer to repay the debt) in the eurozone. Early in the month Standard & Poor’s (S&P) spooked market participants by falsely reporting a downgrade of French government debt. The announcement was quickly retracted, but caused a flurry of market activity nonetheless. Fitch Ratings downgraded the government debt of Portugal to below investment grade during November (following S&P’s downgrade in July), and the government debt of Hungary was also marked lower. Belgium’s government debt was also downgraded, although it managed to retain its investment grade status.

Further bad news continued to come out of the U.K. and the eurozone during the month. Eurozone third quarter growth was confirmed at only 0.2% and showed no sign of improvement from the second quarter’s gross domestic product release (also 0.2%). Inflation in the region remained elevated and unemployment continued to rise, reaching as high as 22.8% in Spain. While inflation in the U.K. declined in October, at 5.0% it still remains notably higher than the target of 2.0% and the country’s growth expectations for 2012 were revised lower from previous forecasts.\

While some economic data released in November indicated that the outlook for the U.S. economy may be improving, positive news was partly overshadowed by concerns about the country’s budget deficit and how it is going to be tackled. The U.S. Joint Select Committee on Deficit Reduction, or the Super Committee, was set up in August as part of the country’s debt ceiling agreement.* The aim of the committee was to establish a plan to reduce the U.S. budget deficit by $1.2 trillion within 10 years. The failure to do so by the 21 of November deadline led to the announcement of a series of automatic spending cuts (which are scheduled to be implemented in January 2013) and caused further stock market declines.

Although U.S. third quarter growth estimates were revised lower, from 2.5% to 2.0%, there was some good news during the month. Inflation, as measured by the Consumer Price Index, fell to 3.5% and retail sales recorded their largest rise in close to two years, driven partly by large numbers of purchases made on Black Friday (traditionally the first day of the Christmas shopping period). U.S. consumer confidence levels have also shown signs of improvement. The Thompson Reuters/University of Michigan Index, a measure of consumer confidence, reported a rise to 60.9 in October from 59.4 the previous month.

Globally, November did end on a positive note. The central banks of the U.S., the U.K., the eurozone, Japan, Canada and Switzerland announced a joint plan to help shore up the world’s financial system, which will come into effect on 5 of December. Under the programme, commercial banks will be able to purchase U.S. dollars more cheaply, enabling them to have access to funds more easily. The news was welcomed by investors and resulted in a market bounce in the final days of the month.

Market Impact

Mirroring the turbulent summer months and in a direct turnaround from the leadership witnessed in October, global government bonds performed best in November. Corporate bonds struggled in comparison and high-yield bonds also fell out of favour. High-yield debt is rated below investment grade and is considered to be riskier. However, emerging market debt, which is also considered to be risky, held up comparatively well during the month. Within government bonds, demand for traditional “safe haven” issuers, such as the U.S. and the U.K. improved, but declined for struggling eurozone nations. As a result, yields (which move inversely to prices) for these country’s government bonds, particularly Greece, rose for the month.

Global equity markets faltered in November and many of the gains witnessed in October were reversed. Risk aversion rose and consequently defensive sectors were favoured. Consumer Staples, a sector comprised of “essential” purchases such as food, drink and household items, was the only area to end the month in positive territory. After briefly rebounding in October, the cyclical (sensitive to economic fluctuations and tend to do poorly when confidence is low and economic contraction is anticipated) Financials and Material sectors once again led the decline. Those banks directly impacted by the eurozone crisis weighed on returns for Financials.

Index Data

• The MSCI AC World Index, used to gauge global equity performance, fell ($) 2.99% in November.
• The Barclays Capital Global Aggregate Index, which represents global bond markets, declined ($) 1.75% over the month.
• 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”, fell from 29.96 to 27.80 during the month, but went as high as 36.16 on the 9 of November.
• WTI Cushing crude oil prices, a key indicator of movements in the oil market, rose from $93.19 a barrel at the end of October to $100.36 by 30 November.
• The Japanese yen strengthened against most currencies in November, while the euro weakened. The U.S. dollar fell marginally against the Japanese yen, but gained against the euro and sterling. The U.S. dollar ended the month at $1.57 against sterling, $1.35 versus the euro and at 77.63 yen.

Our View

In light of the uncertainty and recent pain, we no longer favour stocks over bonds, but rather have a neutral perspective. Although the economic outlook has been downgraded by economists, in our opinion, the data still supports a positive view of overall business activity in the U.S. The European core nations (those with the largest economies) are struggling, but do not yet appear to be in recession. Developing markets have also seen a notable slowdown in growth. U.S. equities are expected to benefit from continued earnings growth and exceptionally low valuations. We favour high-yield bonds over treasuries and investment-grade debt. High-yield bonds appear priced for a recession that we do not think will materialise. We remain neutral to emerging-market debt and equity.

*The debt ceiling reflects the maximum amount of money that the U.S. government is allowed to borrow. After months of political wrangling, a deal was reached in August to raise the U.S. debt ceiling to keep the country from going into immediate default.

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