Equities lose ground, bonds perform better
After three strong months, equity markets took a break in April. The weakness was widespread, with the S&P 500 Index finishing down 0.63 percent and the Nasdaq down 1.46 percent. The lackluster market performance was somewhat inconsistent with what on the surface was strong U.S. corporate earnings performance. As of month-end, 72 percent of S&P 500 companies had beaten analyst earnings estimates. Part of the reason for the high “beat” percentage appears to have been the result of analysts adjusting their first quarter estimates too far downward. That, combined with disappointing guidance from several major firms, prevented a continuation of the equities rally.
Technically, domestic indices are bouncing around their 50-day moving averages, which have started to turn downward. This isn’t a positive sign and by itself could suggest further weakness. The indices remain well above their 200-day moving averages, however, and this still implies a positive long-term trend.
International markets were also weaker and underperformed U.S. stocks, with the MSCI EAFE Index closing down 1.96 percent and the MSCI Emerging Markets Index down 1.48 percent. International indices have moved decisively below their 50-day moving averages, which have also turned down. As with the U.S. indices, they remain above their 200-day moving averages, suggesting caution but not necessarily major concern.
Fixed income, in contrast to equities, showed strength in April, with yields dropping on Treasury bonds and municipals across the board. Spreads generally increased slightly for corporates. The general retreat from the first quarter’s risk-on trade and the partial resumption of the flight to quality resulted from a recurrence of worry about the European financial crisis and weaker U.S. economic data. The Barclays Capital Aggregate Bond Index returned 1.11 percent, and, reflecting these factors, the Barclays Capital U.S. Corporate High Yield Bond Index returned 0.32 percent for the month.
Renewed concern about Europe
Once again, Europe led the headlines, with renewed economic and financial problems in the peripheral countries, joined by greater evidence of economic weakness and political turmoil in core countries. Notably, yields for Spain’s debt continued to creep up, as concerns about its finances grew.
Another growing concern was that the European Central Bank’s Long-Term Recovery Organization (LTRO) funds, which had been lent to troubled banks, may have been largely invested in government debt. This may have been one of the factors that held down European sovereign yields in the first quarter. Now that the LTRO’s funds have largely been invested, not only are yields starting to rise again, but European banks may be even more exposed to sovereign credit risk than before.
The weak economic and political situation has spread across Europe, with the United Kingdom and Spain both in mild recession and the Netherlands contemplating the resignation of its prime minister and his cabinet. In France, the Socialist Party candidate, who finished first in the initial round of the nation’s presidential election, has openly called for renegotiating the fiscal agreements underlying the eurozone. Following up on these campaign promises would likely threaten the Franco-German core. Consequently, uncertainty is still growing, as the political costs of austerity become more apparent to voters across the European Union. The fact that dissolution of the eurozone is now openly discussed highlights the uncertainties that the continent faces.
U.S. economic data sending mixed messages
The U.S. economy sent conflicting signals in April. Employment figures showed a slowdown in jobs growth. March payrolls increased 120,000, which was exactly half of the previous month’s 240,000 new jobs. Initial unemployment claims also ticked up toward the end of April, rising to 388,000. While the trend still indicates improvement, the slower growth in jobs and the simultaneous rise in initial claims warrant some caution going forward.
The Bureau of Economic Activity estimated that gross domestic product (GDP) rose 2.2 percent in the first quarter of 2012. This was lower than some observers had hoped for, but the underlying makeup of the growth was encouraging, with consumer spending driving progress and a reduction in government spending detracting from the headline number.
Consumer demand remained strong in April as well and may be starting to take over from business inventory investment as the primary driver of growth. Retail sales continued to increase at strong levels, and overall spending appeared to remain at sustainable levels, despite some decrease in overall savings rates.
Although economists had worried that manufacturing might slow in April, the ISM Manufacturing Index eased investor worries by rising somewhat during the month. Anecdotally, survey respondents appeared to believe that improving demand for products was offsetting the macro uncertainty coming from Europe.
The housing market displayed signs of stabilization, with price indices showing small gains over the previous year. The S&P Case-Shiller Home Price Index posted a small increase, as did the CoreLogic Home Price Index. Some of the data from the retail sales figures also supported a stabilization of the housing market.
Finally, state and municipal tax receipts have been trending up, suggesting that the governmental sector may cease to be a drag on growth and may even start to add to employment and spending. This would be a significant change relative to the past several years.
Overall, the data has been mixed, but it appears that growth can reasonably be expected to remain at the current low-to-moderate levels; however, the hopes for an acceleration of growth that had started to emerge at the end of the last quarter appear to have been premature.
Staying focused on the long term
April provided both the bulls and the bears with ample fodder for their respective viewpoints. Bulls were pleased to see volatility falling, 2012 S&P 500 earnings estimates rising, and housing and manufacturing data improving. Bears focused on weaker employment growth, Europe worries, and peak-level margins. Many of these factors could fluctuate as the year progresses, pushing the pendulum one way or the other. With this in mind, investors would do well to remember that patience in the short term can be a key way of achieving investment goals over the long term.
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. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. 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 Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. 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 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. The Barclays Capital U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.
Authored by Brad McMillan, vice president, chief investment officer, at Commonwealth Financial Network.
© 2012 Commonwealth Financial Network®