Ed Grzybowski, Chief Investment Officer
Equity and fixed-income markets welcomed the Federal Reserve’s January 25 announcement that it plans to maintain historically low short-term interest rates at least through late 2014, a year longer than previously indicated. The Fed’s extension of its low-rate commitment reflects a degree of caution about the strength of the U.S. recovery, despite some continued signs of improvement.
The preliminary estimate of fourth-quarter U.S. GDP growth, announced Friday morning, came in at 2.8%, slightly below consensus estimates of approximately 3% and above the third quarter’s 1.8% growth rate. Earlier in the week, good economic news included a larger-than-expected gain in durable goods orders, a bump in the Conference Board’s index of leading economic indicators and an uptick in home prices as measured by the FHFA House Price Index. These positive signs were tempered by continued declines in both pending and new home sales, as well as an increase in weekly first-time unemployment claims.
Meanwhile, fourth-quarter earnings releases have been underwhelming so far. Of the approximately 130 S&P 500 Index companies reporting as of January 25, only 58% saw positive earnings surprises, versus 68% for the full fourth quarter of 2010. Weaker fourth-quarter results likely reflect last summer’s slowdown, poor earnings from some of the largest names in the financial sector and the lagged effects of flooding in Thailand, which by one estimate may have reduced global GDP growth by as much as 0.5%.
Overall, market sentiment has turned more bullish in the first few weeks of 2012. The “risk on” trade has resumed, with U.S. and developed foreign equity markets up about 5% year-to-date through January 25, and emerging markets up more than 9%. U.S. and European bank stocks have rebounded strongly following 2011’s dismal performance, while the VIX, or “fear index” (a way of measuring the market’s expectations of volatility in the S&P 500), has fallen sharply in recent weeks, indicating that investors are feeling more confident.
An increased appetite for risk has also been evident in fixed-income markets. The spread, or yield differential, between U.S. Treasuries and lower-rated, higher-yielding bonds, has narrowed, reflecting a combination of the “January effect” (renewed buying after a typical increase in selling at year-end), the availability of cash to be put to work, reasonably strong U.S. economic data and growing comfort with the status of the European sovereign debt crisis.
At midweek, reports out of Athens indicated some progress had been made in previously stalled negotiations between the Greek government and its private creditors regarding a coupon rate on new Greek bonds to be issued in a voluntary debt swap. European finance ministers had rejected an earlier proposal for a higher rate. Agreement on these terms is seen as key to helping Greece avoid a disorderly default. In contrast to hopeful signs on Greece, fears about Portugal’s deteriorating financial condition rose sharply, with yields on Portuguese debt climbing to record highs.
Looking ahead, the week of January 30 will bring a wave of U.S. economic releases, including the latest numbers on personal income, consumer spending, monthly payrolls, unemployment, factory orders, construction spending and other data that will help shape the direction of the markets. In the near term, we believe there is room for equities to advance further, but we are also monitoring sentiment closely. Additionally, if confidence in Europe continues to improve, we could see more strong performance in some higher-yielding, non-Treasury sectors of the fixed-income markets.
The information provided herein is as of January 27, 2012.
The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons.
Past performance is no guarantee of future results.