Mid-term bond yields were the most affected during the November selloff. Yields on 5 and 10-year Canada bonds rose 37 and 27 basis points, respectively. Those compared with increases of 21 and 5 basis points for 2 and 30-year bonds, respectively. The weaker performance of mid-term Canada bonds tracked a similar shift in U.S. Treasury yields during November, and reflected investor expectations that future central bank rate increases were more likely with the improving economic trend.

Provincial bonds were the worst performing sector in the month, declining 1.35% on average. In addition to their typically longer duration, provincial issues were adversely affected by slightly wider yield spreads versus benchmark Canada bonds. The corporate and Canada bond sectors each declined 1.05% in the month. Canada bonds were impacted by higher yields causing lower prices, while the higher-yielding corporate bonds were hurt by widening yield spreads for short and mid term issues. Among the various industries in the corporate sector, financial issues experienced the greatest weakness due to concerns about the European sovereign debt crisis and anticipated changes to regulatory capital requirements.

One of the disappointing aspects about the recent economic recovery has been the stubbornly high unemployment rate in the United States, but we believe that may be about to show significant improvement. As can be seen in the chart below, the experience of the recessions over the last 30 years has been that the unemployment rate lags the number of new claims for state unemployment benefits by as much as a year or two. In recoveries, that makes sense because businesses have to stop laying off workers before they will consider hiring new ones. Since the peak in initial claims in early 2009, they have fallen sharply and currently are the lowest in 26 months. Historical experience suggests that should lead to falling unemployment in the next few months. Improving labour market conditions would result in stronger consumer spending and the U.S. economic recovery would transition from one sustained by fiscal and monetary stimulus to a more self-sustaining one.

Stronger U.S. economic growth should also be beneficial for Canadian growth. The weak trade situation in this country will only improve with increased demand for our exports from our main trading partner. Fortunately, we anticipate that will occur in the coming months, although we anticipate perhaps a quarter delay before Canada benefits from the U.S. economic acceleration. We anticipate that the markets will begin anticipating higher yields in early 2011, and we expect to position the portfolio more defensively in the coming months.

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