February 2011 Market Commentary

Markets deliver gains in February

Equity markets delivered positive returns for the month, but volatility returned in force at month-end. Concerns over political instability in Egypt and Libya were enough to send oil prices higher, and stock markets around the world sold off on the unfolding story. Despite month-end volatility, it was the fourth straight month of gains for the Dow Jones Industrial Average and the S&P 500 Index.

 

The Dow returned 3.16 percent in February and has advanced 6.11 percent this year. The S&P 500 has also had a strong start, up 3.43 percent in February and 5.88 percent for the year. In addition, international markets have seen gains, despite continued protests in North Africa and the Middle East. The MSCI EAFE Index gained 3.30 percent in February and is up 5.73 percent this year. The risk trade has been less favored in international markets, as the volatile MSCI Emerging Markets Index has lost 3.79 percent year-to-date.

 

Bonds have done little for investors over the month or year, although the Barclays Capital Aggregate Bond Index has managed to eke out a small gain. The index advanced 0.25 percent in February and 0.37 percent for the year. Interest rates on the 10-year bond have eased lower, to 3.41 percent, since the recent peak of 3.73 percent near the beginning of February. Although not historically high, the move from last year’s low of 2.38 percent could begin to hamper growth, as a result of increased borrowing costs. Higher rates have slowed mortgage activity, hurting the already sluggish housing situation. In the near term, we believe the Federal Reserve will likely continue to keep short-term rates at or near 0 percent to help fuel the rebound in economic activity.

 

Some signs of spring for the economy

The employment situation seems mostly unchanged as of late, but there have been a few positive signs. Partially due to a data revision, the unemployment rate fell to 9 percent by January’s end. In addition, weekly initial claims for unemployment benefits fell below 400,000 twice during February, indicating potential future job growth. Actual growth in payrolls has remained slow, but this may be in some measure attributable to particularly bad weather in January.

 

 

Much like employment, the housing sector has sent mixed signals and showed very few signs of a turnaround. Again, higher mortgage rates have certainly not helped. Home sales, especially in certain regions of the country, have shown some life; however, home prices have continued to fall, with the Case-Shiller 20-city price index down 0.41 percent in December. As better weather approaches, pent-up winter demand may help to improve the situation.

 

In contrast with the housing sector, manufacturing has been roaring ahead. As of the beginning of February, the ISM Manufacturing Index had risen to its highest level since June 2004. The Philadelphia and Richmond Fed Manufacturing indices also proved stronger than had been anticipated. The recent spike in oil prices could provide a headwind to manufacturing, as more expensive inputs squeeze margins. Still, with consumer confidence improving to levels not seen since February 2008, manufacturers will likely maintain goods production to meet continued demand.

 

Troubles in North Africa and the Middle East

Protests spread across North Africa and the Middle East (see map below). By the end of February, at least nine nations had experienced demonstrations.

 

To better understand the extent of the protests, it is helpful to review a brief timeline of the

unfolding events. Demonstrations began in Tunisia last December 17, leading to the resignation of its president, Zine al-Abidine Ben Ali, on January 14 of this year. In Algeria, riots commenced in early January, followed quickly by protests in Jordan. Unrest spread from North Africa to the Middle East, where protesters in Yemen called for the resignation of President Saleh. Egypt followed, with massive demonstrations that led to the resignation of President Mubarak on February 11. Finally, the contagion spread to Bahrain, Iraq, and Iran, as citizens continued to protest government repression. Given the intensity of each new disturbance, it seems unlikely that the level of unrest in the region will abate anytime soon.

 

Markets mostly ignored the escalating protests and violence until the troubles surfaced in oil-producing Libya. Oil prices spiked sharply higher, sparking a global stock selloff. Uprisings could spring up in other nations, causing further disruptions in financial markets.

 

Figure 1: Middle East, 2011

Source: BBC

 

Will the troubles spread?

Although the current state of affairs doesn’t appear to warrant concerns about oil supply, any signs of turmoil coming from Saudi Arabia would be cause for reevaluation. To date, no protests have been reported, but there have been calls over the Internet from a small group of individuals to stage a “day of rage” on March 11. In addition, governments in other parts of the world have shown signs of worry about a domino effect. In China, demonstrations in support of a “jasmine revolution” were met by SWAT teams, plainclothes police, and attack dogs.

 

The fact that governments in key economies are taking the possibility of revolt seriously means that investors should also keep a very close eye on how events unfold. Continued unrest could be an important influence on markets moving forward.

Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Free Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.

Authored by Simon Heslop, CFA®, director of asset management, at Commonwealth Financial Network.

© 2011 Commonwealth Financial Network®

Commonwealth Financial Network

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