Interest rates once again played a key role this quarter, as equities performed poorly. In the U.S., the 10-year Treasury yield reached a 15-year high, prompting a drop in stock prices and lower returns for fixed income. Canadian, U.S. and most international equities saw declines.
Bond yields in North America trended higher, as sticky inflation and concerns over supply-and-demand dynamics weighed on fixed income markets. Canadian inflation, now primarily driven by oil prices and rising mortgage interest costs, surprised to the upside. Further rate hikes are unlikely to be as effective against inflation going forward.
The U.S. dollar was particularly strong against all major currencies during the quarter, while the Canadian dollar showed modest strength against other currencies.
This quarter, the S&P/TSX Composite Index fell by 3.05%, with only energy and health care seeing gains. The price of oil (as measured by WTI) broke above US$90/bbl, contributing to energy’s performance.
Canadian equities were volatile during the quarter and, despite the gains in oil, ultimately dropped in value, alongside its global peers.
The most positive single contribution during the quarter came from Celestica, a data centre services and chip manufacturing company that gained over 73% in the quarter on positive results from the AI tech euphoria.
The S&P 500 Index fell by 3.65% during the quarter, with energy and communications being the only sectors gaining ground.
While the U.S. benchmark had considerable gains throughout the first half of the summer (gaining 19.5% for the year to July 31), investors shifted focus to the impact of higher U.S. Treasury yields. Rising yields weighed on stock market valuations, with the index retreating during the back end of the quarter. It ended 6.56% down from its peak at the end of July to a nine-month return of 11.68%.
Like their global peers, international equities mostly lost value, due to pressure from rising bond yields. The Europe, Australasia and Far East (EAFE) Index dropped by 4.71% this quarter in U.S. dollar terms (-2.44% in Canadian dollars).
Currency was an issue for international markets: in the face of a strong U.S. dollar, we saw generalized weak returns from regional indices.
However, some countries realized positive returns in local currency. For example, Japanese equities, as measured by the TOPIX Index, gained 1.52% in Japanese yen, yet declined 1.93% in U.S. dollar terms.
Bond yields rose during the quarter on continued hawkishness from global central banks. Inflation, still above 3%, is proving stickier than some expected. Markets are therefore coming to terms with the notion that interest rates will be higher for longer, triggering a rise in long-term yields.
The Bloomberg Global Aggregate Index returned -3.59% in U.S. dollar terms, while the Canadian Universe Bond Index also retreated, by 3.87%. U.S. high-yield bonds had modest returns, with the ICE US High Yield Index gaining 0.51% during the quarter in U.S. dollar terms (and 2.72% in Canadian dollars).
Looking ahead to the rest of the year
Inflation-fighting high interest rates are boosting long-term yields, which is hurting both bond and stock valuations. However, this may be more detrimental to comparatively expensive U.S. markets than Canadian and international equities.
Despite rising rates, bonds continue to be a favoured portfolio diversifier going forward, and fixed income remains attractive on a forward-looking basis, given its decades-high yields.
We enter the year’s final quarter with stickier-than-expected inflation, increased recession fears and a re-evaluation of stock multiples in the face of higher-for-longer interest rates. While a diversified approach may be wise, we’re still not negative towards equities. International and emerging markets remain promising for diversification benefits, while profit-taking in the highly valued U.S. markets could prove beneficial.
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