Macro Environment Comments December 31, 2011


Capital markets have a strong distaste for uncertainty and uncertainty was the order of the day in 2011, courtesy of the Euro zone sovereign debt crisis. As a result, equity markets in Britain, Germany, China and Japan were all weaker in 2011 with negative performance ranging from -6% in Britain to -20% in China. Meanwhile, Canada’s major stock index was down 11.9% in 2011. Reflecting a modest in-country economic recovery, US equity markets bucked the trend, up 0.4% in US dollars and up 2.7% in Canadian dollars.

Until there is greater clarity on a solution to the Euro zone crisis, equity markets are expected to remain volatile in the short-to-medium term, reacting positively or negatively to the latest turn in ongoing European negotiations.

Short-term volatility higher but longer-term risk reverts to mean

A recent study by Wells Capital Management reported that while short-term volatility and risk have clearly increased as measured by daily and weekly stock price movements (standard deviations), longer-term volatility measured by monthly, quarterly and annual price movements is similar to historical averages.

Although hard to believe, stock price volatility for monthly periods is lower compared to most of the 1980s and 1990s are very close to post-war average levels.

To long-term investors, this is meaningful, because it signals that our investing risks remain at normal levels. In short, in these uncertain times, long-term owners should be more certain than ever in their investing strategies.

Improving economic activity outside Euro zone

Non-Euro zone market participants continue to demonstrate stable or improved economic activity. According to the most recent Global Purchasing Managers Index (PMI), 17 of 22 countries reported flat or rising measures of economic health within their manufacturing sectors. Large gains were noted in Australia, India, Taiwan and the United Kingdom.

These data suggest that the global economy, excluding headwinds in the Euro zone, is evidencing some signs of renewal.

In addition, despite modest economic growth in the US over most of the past decade and sluggish stock price performance, corporate profitability and financial health have rebounded strongly as evidenced in the chart below.

North American corporate balance sheets are generally very healthy and cash reserves have been building. Deployment of this cash will ultimately drive improved economic activity.

US – Confidence Returning (Slowly)

Recent US economic data have generally surpassed consensus expectations. Employment levels have improved and we have seen some positive signs, albeit modest, in areas such as light vehicle sales.

Perhaps most important, US consumer confidence appears to be on the upswing. The Conference Board reports that US consumer confidence has improved from a level of 40.9 in October to 56.0 in November. Other improved confidence measures are outlined in the next chart.

Macro Summary

Short-term capital market volatility will likely continue until there is improved visibility on a firm solution to the Euro zone debt crisis (or until the world’s attention is refocused elsewhere). However, outside the Euro zone and including the US, there is clear evidence of growing economic activity and consumer confidence. Improving global economic data and solid corporate operating performance should support the macro environment in the medium to longer term.