CIO Commentary: May 2012

June 5, 2012

Weakening employment data here in the US, battles between growth and austerity policy in Europe, concern over China’s ability to sustain high growth — all have investors on edge.

After the best start since 1998 for equity markets in the first quarter of 2012, stocks have recently retreated back to where they were at the start of the year. On Monday, June 6, 2011, the Standard & Poor’s 500 (S&P 500) closed at 1286.17, and the Dow Jones Industrial Average (DJIA) was at 12089.96. Remarkably, on June 1, 2012, the S&P 500 closed at 1278.04, while the DJIA finished at 12118.57. However, the silver lining (again this year) is that bond prices have increased recently after being left behind in the first three months and yields have declined even more, benefitting balanced and fixed-income portfolios. In fact, as we speak, 10-year US Treasuries are yielding only 1.5%.

Our strategy & outlook
Prior to the correction, we reduced our equity exposures in the Balanced Funds, taking advantage of the appreciation at the start of the year. We accomplished this by reducing allocations to international developed and US small cap equities, given the potential for increased volatility. Recently, we increased our allocation to emerging markets equities, taking advantage of price weakness. Finally, we continue to look for higher-yielding substitutes for the lowest bond yields in the last 50 years, where prudent and appropriate.

While these steps can somewhat cushion your assets against the possibility of another 2010 or 2011, we don’t want to lose track of longer-term opportunities. Earnings, especially in the US, have been relatively strong and housing shows signs of stabilizing. Commodity prices have fallen, along with inflationary expectations, leaving more room for monetary authorities to continue their easing policies. Although we have taken some money off the table in equities in balanced funds, we do favor stocks over bonds in the longer term.

Our longer-term view

Bond Yield vs Dividend Yield vs Inflation Rate



Bond-Dividend-Inflation Comparison Chart (6-5-12)

Source: Bloomberg and CLSA

The first column in the table above shows 10-year government yields of North American, European, and Asian developed nations. Next, current dividend yields on equities are shown, followed by a calculation of the ratio of equity dividend yields to bond yields. We have shown this ratio for October 2011 and June 2012 to illustrate the improvement. Finally, the current inflation rate is compared to the 10-year government bond yield to illustrate whether your return from lending money to selected governments would be a good idea, or whether your returns could be eroded by inflation. Equity dividend yields (an important part of total returns for equities) have become very attractive relative to bond yields!

Our strategic orientation is to survive these more difficult periods by preserving your assets in the short term, and also to act on your behalf to position the funds for longer-term benefit. Our utmost concern is to prudently keep aware of both the risks and opportunities. We will continue to keep you informed.




  • US equity indices were down in May, following a slightly negative April. The Dow Jones (DJIA) was down 5.8%, outperforming the S&P 500 and the NASDAQ Composite by 20 basis points (0.01% or bps) and 120 bps respectively, reflecting a more pessimistic mood among US investors after they received a set of largely disappointing data. The unemployment rate increased to 8.2% in May, real GDP growth was revised from 2.2% to 1.9% for 1Q12, and housing data for April proved mainly disappointing. Somewhat more positive were consumer prices and general inflation, which were flat in April. Gasoline prices continued their decline.
  • The developed international equity index, MSCI EAFE, lost 11.5% in May, underperforming the S&P 500 by 550 bps. While very large, this decline is not surprising given the refocus of the world’s attention on European sovereign debt problems, specifically in Greece, Spain and Italy. A big factor in the decline of the EAFE index was the performance of the US dollar, which appreciated in May and accounted for 400 bps of the 11.5% decline. Emerging markets were down a similar 11.2%.
  • Bond yields reflected the growing unease in the market as they decreased across the board for US government securities in May. The 5-year Treasury yield decreased 15 bps to 0.66%, while the 10-year Treasury yield declined 36 bps to 1.56%. Keeping short-term rates very low, the Federal Reserve left the overnight lending rate unchanged at 0-0.25%. The Fed meets again on June 20 amid and there is considerable speculation about that meeting.
  • Mirroring the positive return in Treasury debt, corporate bonds gained 0.8% in May and are up 4.3% for the year-to-date period.

Economic & Geopolitical Headlines

  • European sovereign debt concerns dominated the news in May. Spain and Greece shared the headlines and the markets’ attention with increasingly dire reports and data.
  • Eurozone unemployment increased from 10.3% in April to 10.9% in May, with the unemployment rates in Spain and Greece reaching desperate levels of 24.3% and 21.7% respectively.
  • The social unrest from high unemployment and “austerity” policies are also impacting the voting booths. French President Nicolas Sarkozy lost his reelection bid to socialist candidate Francois Hollande. In Greece, the two major incumbent parties received clear messages when voters turned out en masse to support Syriza, the anti-austerity party. Since no group was able to form a coalition after the first election, all eyes are on Greece for the election rerun on June 17. A win for Syriza would be a resounding statement for anti-austerity and will largely be perceived as tantamount to a vote against the Eurozone.
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