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| Fourth Quarter 2008 | ||
IN THIS ISSUE |
Market Commentary | S&P/TSX Composite Sector Performance |
| Market Benchmarks | Highlights | |
| Report of the Quarter | ||
Market CommentaryCanadian Economic Overview The fourth quarter of 2008 continued to reflect the dismal course of the U.S. economy and severe turbulence in global financial markets. Global economic growth, which weakened in the first half of 2008, remains unsettled. Economic activity has been moving slowly over the year, as the economy has suffered from plunging commodity prices, a depreciated Canadian dollar, severe losses in the value of the stock market and an automotive recession. The Bank of Canada expects 2009 performance to follow in the footsteps of 2008’s fourth quarter. However, moderate improvement is expected into 2010 as the economy benefits from stronger global growth and improvements in credit conditions. With the economy so depressed, Canada reported weak employment figures in fourth quarter 2008. Employment declined by roughly 34,000 jobs in December while the unemployment rate rose to 6.6%. The economy did add 98,000 jobs from December 2007 to December 2008; however, this is at a much slower pace than the 358,000 jobs added over the same period in 2007. South of the border, the U.S. reported job losses of roughly half a million in December 2008, pushing up the unemployment rate to 7.2%. Monetary Policy On October 21, 2008 the Bank of Canada lowered the target for the overnight rate to 2.25%. On December 9, it further reduced the target for the overnight rate to 1.5%, stating that global financial markets remain harshly strained and that the Canadian economy is entering a recession as a result of the weakness in global economic activity. The outlook for inflation in Canada has been lowered, with the Bank of Canada expecting core inflation to remain below 2% until the end of 2010. In the short term, the Canadian economy is likely to see lower interest rates, continued pressure on commodity prices, a budget deficit and lower housing prices – all contributing to a weaker Canadian dollar. The Bank of Canada states that further monetary stimulus is likely to be needed to achieve the 2% inflation target over the medium term. In 2008, the Canadian dollar experienced its biggest decline on record, weakening 19% since the global recession negatively impacted the demand for commodities. The commodity-driven currency may also continue its decline into 2009, as falling crude oil prices affect investment in Canadian oil-producing regions. The Canadian dollar weakened relative to its U.S. counterpart in the fourth quarter of 2008. Nevertheless, the Bank of Canada holds that the depreciation of the Canadian dollar will continue to somewhat offset the effects of lower commodity prices and weaker global demand. The Canadian dollar started 2008 at US$1.004, closed at US$0.9406 on September 30 and finished at US$0.8100 on December 31. U.S. Monetary Policy The U.S. housing market collapse, along with persistently weak credit conditions, a weak job market and slower consumer spending, led the Federal Reserve to slash interest rates three times during fourth quarter 2008. On October 8, the Federal Open Market Committee (FOMC) announced a lowering of the target rate for federal funds to 1.5%, citing weakening economic activity. On October 29, the FOMC lowered the target again to 1%, citing a decline in consumer expenditures. Then on December 16, the FOMC decided to establish a target range for the federal funds rate of 0-0.25% as the outlook for the U.S. economy weakened further. Tighter credit conditions, the ongoing housing contraction and slowing export growth are all likely to weigh on economic growth over the next few quarters. However, the FOMC hopes that ongoing measures to promote market liquidity will help foster moderate economic growth in the U.S. over time. The Bond Market While third quarter 2008 saw Canadian bond prices fall as investors worried about credit conditions, fourth quarter saw positive returns for Canadian bonds, with government bonds leading the way as interest rates were slashed. The broad market DEX Bond Universe Index finished off the quarter returning 4.50%, up from -0.37% in third quarter. The index returned 6.41% for the year. Canadian bonds at the long-term maturity tiers were the best-performing segment of the market for the quarter, returning 5.21%. Mid-term and short-term bonds also achieved positive results, returning 4.25% and 4.30% respectively. Canadian Equity Markets Turmoil in global financial markets and fears of a global recession continued to shock equity markets throughout fourth quarter. Canadian equity market started off the first half of 2008 on positive ground; however, the S&P/TSX Composite Index along with other world indices plummeted in both the quarter and the year, with global equity markets losing trillions of dollars in 2008. The S&P/TSX Composite Index fell Canadian Style Analysis Canadian stocks at the large capitalization tier continued to outperform their smaller capitalization counterparts in fourth quarter and for the year, since smaller capitalization stocks tend to take the biggest fall during economic downturns. Many smaller-cap stocks have continued to face margin pressure from the recent market volatility, pushing investors toward the safety of larger capitalization stocks. The S&P/TSX 60 Index returned -22.68% for the fourth quarter and -31.17% for the year, while the S&P/TSX Small Cap Index returned -26.79% for the quarter and -45.49% for the year. Growth stocks were the preferred investment style for the quarter – a reversal of the trend toward value stocks during third quarter. The MSCI Canada Growth and Value indices returned -19.06% and -25.63% for the fourth quarter of 2008. Growth stocks also outperformed value stocks for the year, with growth stocks returning -31.39% and value stocks returning The U.S. Markets As deep gloom continues to spread through the U.S. financial markets, it is no surprise that the U.S. equity market retreated during fourth quarter 2008. The S&P 500 Index experienced negative returns for the fifth consecutive quarter, and posted one of its biggest annual declines in history. In Canadian dollars, the S&P 500 Index returned -9.37% for the quarter and -21.20% for the year 2008. Among the weak performers, the Financials, Materials and Information Technology sectors were hit hardest in the quarter, returning -26.76%, -19.63% and -13.77% respectively. These three sectors were also the worst performers for the year, returning -44.11%, and -32.03% and -28.88%. The weakening credit market has continued to weigh on the earnings of financial services companies, while commodity price reductions due to slowing global growth have negatively impacted the materials and energy sectors. U.S. Style Analysis U.S. value stocks led over growth stocks at the large capitalization tier as measured by the Russell 1000 Value and Growth indices. Small capitalization stocks, as measured by the Russell 2000 Value and Growth indices, saw a similar trend as equity investors piled toward value stocks to avoid the risk of a huge decline in growth stocks. In Canadian dollars, the Russell 1000 Value and Growth indices returned -9.64% and International Markets Throughout the quarter, the worst global financial crisis since the Great Depression walloped international markets and led to the most dramatic international government intervention since the 1930s. Emerging markets generally suffered more than developed ones, and large deficits coupled with foreign debt forced some emerging economies – including Pakistan and Hungary – to seek help from the IMF near the end of 2008. In addition, the GDPs of previously robust economies such as Taiwan, Hong Kong, South Korea and China are shrinking. This is due to a global lack of demand for their exports, blamed largely on increasing difficulty in accessing cheap capital and lower commodity prices. Global economic policies are now focussed on containing the financial crisis amid the ongoing economic downturn; in developed markets, however, no other central bank has matched the aggressiveness of the Fed’s key interest rate adjustments. In 2008, the Fed cut the key lending rate from 5.25% at Dec. 31, 2007 to 0% - 0.25% at Dec. 31, 2008. The European Central Bank, responsible for the Eurozone monetary policy, cut rates from 4.0% at Dec. 31, 2007 to 2.5% at Dec. 31, 2008 despite pressure for more drastic action. The conversion rate between the two currencies was €1 = $1.47 at Dec. 31, 2007 and €1 = $1.39 at Dec. 31, 2008. The Fed’s drastic action has had a notable effect on strengthening the USD from its weakest point in April when €1 = $1.60. Throughout developed Europe, governments injected hundreds of billions of dollars into banks and financial markets to promote liquidity and to offer guarantees on deposits and bank debt. These interventions, though contrary to the free-market economies of those countries, undoubtedly staved off a wider evaporation of public and private capital. In the fourth quarter of 2008, The MSCI EAFE Index, the pre-eminent international equity performance benchmark, finished the quarter with a return of -6.99%, with small-weighted European countries Austria, Belgium, Norway and Greece each recording negative returns in excess of -20%, thus hurting the overall combined return. The MSCI EAFE’s annual return for 2008 is -28.78%. The MSCI World, which measures the equity performance of 23 developed market indices, returned The MSCI EMU – the pre-eminent Europe-only equity performance benchmark – returned -9.30 %, lagging behind its constituent index, the MSCI Euro , which returned -8.52%. Respectively, their 2008 calendar year performance is -33.82% and -32.88%. The poorest performance by a developed international market for the second consecutive quarter was the MSCI Austria Index, which lost -34.07% following a third-quarter loss of -38.32% and bringing one-year performance to -60.25%. The Belgian BEL-20 Index, heavily weighted with beleaguered Fortis and Dexia as well as brewer InBev, was also notably stricken, ending the quarter down -26.84% and bringing one-year performance to -57.66%, just ahead of the MSCI Greece (-57.48%) and the MSCI Norway (-54.86%). Emerging Markets The world’s emerging market economies displayed typically high volatility. Countries in Eastern Europe with high current-accounts deficits and foreign debts were especially sensitive to the economic downturn. Similar to last quarter, European, Middle Eastern and Latin American markets were hardest hit, whereas Asian and African markets were spared the worst. The MSCI Emerging Market index closed well into negative territory for the fourth consecutive quarter, losing -15.89% for an annual loss of -41.44%. The top performing multinational emerging market index for the quarter was the MSCI Emerging Markets Far East Index which lost -7.28%, producing an annual return of -38.09% for 2008. The hardest hit for the second consecutive quarter was the MSCI East Europe index, which lost -39.04% for the quarter, resulting in an annual loss of -61.24% for 2008. The top performing national emerging market index was the MSCI China, which returned 3.63% for the quarter while the bottom performer was Pakistan, which lost -42.35%. Pakistan and India continue to free-fall through bear-market territory with annual 2008 market index performance numbers of -67.54% for Pakistan and -55.76% for India. A small degree of these market losses reflects the rupee’s recent depreciation of nearly 25% against the U.S. dollar through 2008. However, the single largest factor was capital flight from the country, with nearly $13 billion moving out of the India Sensex exchange during 2008. Commodity-heavy Latin American markets that enjoyed significant market surges throughout 2007 again suffered deep losses this quarter as demand dried up and commodity prices plunged. The MSCI Emerging Markets Latin America Index, which until third quarter 2008 had enjoyed eight consecutive quarters of growth, lost -23.33% during the fourth quarter, producing a 2008 annual return of -39.06%. The global financial crisis and plummeting oil and commodity prices have caught up with the less resource-based economies of Mexico and Central America. Mexico’s central bank remains focussed on controlling inflation, though its efforts are being overpowered by the depreciating peso. The year so far has been relatively stable in economic terms compared to the effects of the global downturn felt in other emerging markets, with inflation of around 7%. The MSCI Mexico lost -18.74% this quarter and -28.63% for the year. Elsewhere in Latin America, Brazil’s dependency on oil revenues resulted in such capital flight that Brazil experienced intense currency devaluation through the end of 2008 due largely to the decrease in the value of oil. The MSCI Brazil lost -27.01% through fourth quarter 2008, resulting in an annual loss of -45.03%. The MSCI Far East – the broadest Asian-only developed country equity performance benchmark – recovered 3.81%, bringing annual performance to -15.30%. The index uses a weighting of nearly 91.5% for the MSCI Japan Index, whose gain of 5.66% relieved much of the downward pressure coming from the lesser weighted MSCI Hong Kong’s return of -5.67%, and the MSCI Singapore’s return of -14.38%. The MSCI Pacific Basin Index, which includes the MSCI Far East members along with Australian and New Zealand markets, returned 0.08% for the quarter as Australia’s quarterly performance of -14.78% further diminished the return of this index. The MSCI Pacific Basin Index ex Japan produced a -12.77% loss, illustrating the widespread losses in the Pacific Basin. Emerging Asian markets fared relatively well this quarter compared to their global counterparts, with double-digit losses being the exception rather than the rule. The MSCI Emerging Markets Asia Composite lost -8.89% over the quarter and -40.91% for the year, reflecting the poor performance of nine Asian Nations in the early part of 2008. 1All numbers reflect gross index performance in Canadian currency 2Comprises 90% of the MSCI EMU, taking the largest and most liquid securities.
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