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Stock market volatility picked up significantly in September, with the Dow Industrials experiencing triple-digit moves each day during the final week of the month, but the net result was not significant in terms of the monthly index moves. However, the ‘calm and quiet’ demeanour of investors over the past few quarters appears to have ended as we saw a huge difference in monthly returns between various sectors of the market. While the Dow Industrials were down only 0.3% in September, trading was more ‘selling intensive’ north of the border as the S&P/TSX Index lost 4.2%, pushed down by a 10% fall in the Energy sector and an 11.5% drop in the Basic Materials group. International markets also demonstrated similar volatility; while Japanese and Chinese stocks gained 4.8% and 6.6%, respectively, in September, the MSCI Emerging Markets Index dropped by 7.6%, driven in large part by an 11.7% collapse in the Brazilian market (World Cup ‘hangover?’). The Hang Seng index in Hong Kong fell 7.3% on worries about the demonstrations surrounding the control of China over the next round of elections in Hong Kong. The bottom line is that investors in stock markets all over the world have gotten a lot more nervous in the past few months about a variety of geo-political risks, slowing growth in Europe and China as well as the ongoing worries about when the U.S. Federal Reserve will finally start to ‘pull away the punch bowl’ of record low interest rates. The U.S. stock market has held up better than most due to its role as a ‘safe haven’ investment, but the pressures from foreign markets could start to have some pushback on U.S. returns very soon. The technical profile of the stock market continues to worry us as well. The smaller stocks have clearly performed much worse than the larger companies, which was typical of the later stages of prior bull markets. The funds flow remain positive for now as institutional money moves from bonds to stocks, as shown by the late-day recoveries that the market has seen in the past few weeks. But those flows could reverse quickly if confidence in the economic recovery starts to falter. The table below shows the returns of the Canadian, U.S. and International stock markets over the past month, quarter and year-to-date periods.
The big story in the past quarter was the strength of the U.S. dollar as the trade-weighted value of the greenback rose 7.8%! The key reason for the gain was simple; interest rates are expected to rise in the U.S. while they continue to fall in the rest of the world. Since international capital is highly mobile, the funds can be shifted quickly and most of the money has been moving to the safe haven of the U.S. While the 2.5% yield on 10-year U.S. Treasury Bonds is extremely low by historical standards, it still compares very favourably to the 0.95% rate on German 10-year bonds and the 0.5% rate on 10-year Japanese bonds. Meanwhile, as the global economy slows down further, investors see no reason to take higher risk and buy 10-year bonds in Italy (2.28% yield), Switzerland (0.4%) or even Canada (2.1%). Whether you call the U.S. currency the ‘best house in a bad neighbourhood’ or the ‘cleanest shirt in the laundry hamper,’ the reality is that investors are not being rewarded for taking a higher degree of risk so they are moving money to the safer option; U.S. stocks and bonds! The chart below from Bloomberg shows how the U.S. dollar has shot higher in the past quarter, breaking out of a long-term trading range, despite the fact that the U.S. now has over US$15 trillion in outstanding debt following the stimulus that came with the financial crisis.
