Lisa Black, Head of Global Public Fixed-Income Markets
Financial markets rang in the New Year amid a steady stream of favorable U.S. economic data. Initial unemployment claims for the last week of 2011 fell by 15,000, pushing down the four-week average to its lowest level since June 2008. Meanwhile, private payrolls grew by about 325,000 in December, according to the ADP employment report released on January 5, well above consensus expectations. This strong showing was reinforced the following day, when the U.S. Labor Department announced that the economy had added 200,000 jobs, while the national unemployment rate dipped to 8.5%, its lowest level in nearly three years.
Among other signs of a strengthening economy are gains in manufacturing activity, rising consumer confidence and robust demand for automobiles. U.S. automakers enjoyed record December sales, and auto production is set to rise by more than 20% in the first quarter of 2012. Even the long-depressed housing market has shown some signs of life, with housing starts and other residential construction activity on the rise as 2011 came to a close.
The generally positive news on the U.S. economy managed to trump concerns over Europe’s sovereign debt crisis on the first trading day of 2012. The S&P 500 Index returned 1.5% on January 3, while higher-yielding fixed-income securities—including high-yield corporate bonds, commercial mortgage-backed securities and investment-grade bonds issued by financial companies—were buoyed by investors’ increased appetite for risk.
Once again, however, anxiety over Europe didn’t stay on the back burner for long. On the plus side, Germany and France held moderately successful 10-year bond auctions at midweek, and the eurozone’s annual inflation rate in December fell for the first time since last July, which may give the European Central Bank (ECB) more flexibility in addressing the sovereign debt crisis. Despite these encouraging developments, eurozone nations still face a mountain of debt that needs to be rolled over in the first quarter, and the regional economy’s continued slide into recession complicates the efforts of fiscally challenged governments to reach budget-neutral levels. Against this backdrop, a decline in European stocks—especially financials—prompted another bout of global equity market volatility at midweek.
Out of this volatility may come potential investment opportunities; valuations of Italian stocks, for example, are at multi-decade relative lows. Germany may also be primed for a better year, as its economy outperforms its eurozone neighbors and German stocks appear attractively valued.
In fixed-income markets, U.S. Treasuries overall look richly priced by historical standards and lower-rated “spread” products appear cheap. As we have seen, however, the relative attractiveness and pricing of these assets is subject to swift and dramatic swings due to Europe’s sovereign debt crisis and other economic and political risks around the globe. When the markets are roiled by such events, as they inevitably will be, we expect U.S. Treasuries will remain a safe haven of choice despite last year’s credit rating downgrade by Standard & Poor’s and continued fiscal policy gridlock in Washington.
The past week’s volatility is a clear indicator that the competing influences of positive U.S. economic news on the one hand and Europe’s ongoing debt problems on the other continue to dominate investor sentiment and market direction, just as they did in 2011. We are also keeping a close watch on developments in China and other emerging markets, where economic conditions and trends will help shape investment opportunities in 2012 and beyond.
The information provided herein is as of January 6, 2012.
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