William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets
Recent data confirms that U.S. economic activity has accelerated in the first quarter, with steady improvements in the housing and labor markets setting the tone. Existing home sales rose 4.3% in January, to their highest level since May 2010, while the inventory of homes for sale fell to a near seven-year low. Home prices, however, remained soft, and may drop further as the foreclosure rate is widely expected to increase in 2012.
A true rebound in housing starts and home sales could lead to the re-employment of many Americans in housing-related sectors of the economy. This would bolster an already improving labor market in which initial unemployment claims over the past two weeks have remained at 353,000, a level that corresponds to annualized GDP growth of over 4%. (Weekly jobless claims below 400,000 indicate healthy employment conditions, and the four-week moving average of these claims has been below this threshold since last November.) Other positive signs for the U.S. economy include booming energy production and robust manufacturing activity.
Globally, the economic environment has been mixed. In the eurozone, both manufacturing and nonmanufacturing activity across the region contracted in February, according to preliminary PMI (Purchasing Managers Index) readings.
After prolonged negotiations, the European Union and the Greek government agreed to a second bailout, but the details of austerity measures have yet to be worked out. Meanwhile, Greek elections loom in April amid a backdrop of rising social unrest. Moreover, many observers are still skeptical, and it remains to be seen whether the severe economic contraction in Greece may ultimately trigger the country’s exit from the euro, despite the funding agreement.
More broadly, we are waiting to see how the terms of the next European Long Term Refinancing Operation (LTRO) unfold. The first offering of this lending facility was widely credited with soothing the 2011 late-year liquidity crisis, when European banks were unable to obtain reasonably priced financing in the capital markets. Scheduled to take place on February 29, the second LTRO offering, which some analysts predict could be significantly larger than the €489 billion extended in December, should provide further reassurance to Europe’s financial system and fixed-income markets.
Elsewhere, Japan is contributing to the global liquidity supply, with the Bank of Japan recently announcing its own version of quantitative easing, along with an inflation target of 1%. These moves triggered a much-needed weakening of the yen, which has depreciated more than 5% against the dollar since the beginning of February and fueled a strong rally in the Japanese stock market, particularly among exporters.
In China, PMI data for February showed manufacturing activity contracting for the fourth consecutive month, reflecting in part a sharp decline in new export orders, which hit an eight-month low. Overall, GDP appears to be slowing toward a 7% growth rate, but in the past week China’s central bank took another gradual step in easing monetary policy to help support growth.
Against this mixed economic backdrop, equity markets have continued to fare well, while exhibiting relatively low volatility. After reaching recent highs early in the month, the S&P 500 Index has traded within a relatively narrow range over the past week. In fixed-income markets, investment-grade bonds have posted flat to slightly negative returns month-to-date through February 22, based on the Barclays Capital U.S. Aggregate Bond Index. In contrast, higher-yielding, non-Treasury markets, including high-yield and global emerging market bonds, have outperformed, reflecting investors’ continuing appetite for risk.
The rise in oil prices (up 10% over the past two weeks) gives us pause for concern. A combination of factors—fear of conflict with Iran, extremely harsh winter weather in Europe and supply disruptions in the North Sea—have contributed to the market’s unease, helping to drive up oil prices to $107 per barrel at mid-week. This increase is also reflected in the price at the pump: with gasoline up another five cents last week, consumers are feeling the pinch and curtailing their spending.
Despite these headwinds, we remain cautiously optimistic about the economy and the financial markets in the near term. The week of February 27 will bring a raft of economic data related to GDP growth, manufacturing, home prices, jobless claims, consumer spending and auto sales—any or all of which have the potential to either reinforce or reshape market expectations of continued economic growth and investment opportunity.
The information provided herein is as of February 24, 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.
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