William Riegel, Head of Equity Investments
The positive market momentum that kicked off 2012 showed signs of hesitation during the new year’s second week of trading, amid some disappointing economic releases. An unexpectedly sharp increase in first-time unemployment claims tempered rising optimism about the health of the U.S. labor market. After the previous week’s welcome decline, jobless claims jumped to 399,000—just shy of the 400,000 level that is seen as a key indicator of stagnant employment. Also disappointing were retail sales, which rose a meager 0.1% in December, undermining upbeat expectations about the holiday sales season.
On the plus side, consumer credit increased by just over $20 billion in November, far exceeding consensus estimates of about $7 billion. Consumers drive more than two-thirds of U.S. GDP, so any sustained increase in consumer credit should translate eventually into higher economic growth and hiring trends. It’s uncertain how long this trend can continue, as personal incomes have remained relatively flat and the savings rate would have to decline further to support higher consumer credit growth over time.
Overall, signs of improving U.S. economic activity have begun to resonate in equity markets globally, where increased optimism has encouraged investors to take on more risk. Following a rotation into relatively safer large-cap stocks in December, year-to-date returns through January 11 show emerging market equities and U.S. small-caps outperforming U.S. large-cap shares. Similarly, in U.S. fixed-income markets, higher-yielding assets, including commercial mortgage-backed securities and investment-grade and high-yield corporate bonds, have outperformed safehaven Treasuries in the first two weeks of the year.
Looking ahead, we will continue to watch market sentiment closely to see if investors tilt toward an optimism that may not align with the macro risks that still pose potentially significant obstacles. Among these are Europe’s looming recession and ongoing sovereign debt crisis. While there were some encouraging signs in the past week, including falling yields on Spanish and Italian government bonds, by Friday markets were focused on speculation that Standard & Poor’s was preparing to announce long-anticipated sovereign credit downgrades of a number of eurozone nations. Speculation become reality late in the day as S&P downgraded France one notch from AAA to AA+. A resolution to the crisis in the eurozone is a long way off, and we expect crisis-related headlines will remain a heavy influence on global market sentiment and performance in 2012. Another concern is oil prices, which have stealthily crept higher and are now back above $100 per barrel, after hitting a low of $76 last October. A move above $110 would almost certainly put a meaningful drag on consumer spending.
Lastly, we are cautious about developments in China. Falling property prices may indicate a broader decline in the growth of related industries. Meanwhile, Chinese import growth fell to a two-year low in December, a sign of weaker domestic demand. GDP figures to be released during the week of January 16 are expected to show that China’s annual rate of growth slowed in the fourth quarter of 2011, perhaps falling below 9%. The good news is that consumer inflation has also cooled, dropping to 4.1% in December, a 15-month low. This may be enough to convince Chinese authorities to loosen monetary policy, either through an interest rate cut or by lowering reserve requirements for banks. Financial markets are hopeful that such a move is in the offing, as it would boost the outlook for global growth.
The information provided herein is as of January 13, 2012.
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