William Riegel, Head of Equity Investments
February proved to be a good month for the financial markets, with most equity and fixed-income indexes posting solid gains. The S&P 500 Index returned +4.32% for the month, while the largest companies in the United States—as measured by the Russell Top 50 Index—gained +5.06%, outperforming the small-cap Russell 2000 Index (+2.39%) and the Russell Midcap Index (+4.15%). Based on MSCI indexes, equity returns in both developed and emerging foreign markets were broadly higher than in the U.S.
Among fixed-income markets, higher-yielding, non-Treasury sectors, including U.S. corporate high-yield (+2.37%) and global emerging market bonds (+2.93%), continued to generate higher total returns than U.S. Treasuries (-0.71%) and the broader U.S. investment-grade universe (-0.02%) during the month, according to Barclays Capital indexes. As Treasury prices declined, their yields inched higher, while remaining very low by historical standards.
Recent market performance has been driven primarily by signs of a strengthening U.S. economy, with the flow of mostly positive news continuing in the last week of February and into the beginning of March. U.S. gross domestic product (GDP) for the fourth quarter of 2011 was revised slightly upward, from 2.8% to 3%, and recent data, including stronger-than-expected regional manufacturing activity, surging auto sales, rising consumer confidence and a steady decline in the number of weekly first-time unemployment claims have been favorable.
However, there are also indications that much of the economic lift has been due to very mild winter weather in the U.S., an easing of disruptions in certain global manufacturing supply chains caused by 2011’s massive flooding in Thailand and inventory restocking. As these impacts begin to fade, we believe that economic growth rates may slow heading into the second quarter. Already we have seen disappointing durable goods orders for January and only modest gains in consumer spending due to higher gas prices at the pump.
As we observed last week, rising oil prices continue to pose a meaningful threat to growth prospects. A larger spike from recent levels of $109 per barrel would limit the amount of disposable income consumers have to spend on goods and services. In addition, while many housing indicators have offered reasons for optimism, home prices in December declined to a new post-bubble low, as measured by the S&P/Case Shiller Home Price Index.
In the equity markets, the bulls remain in charge, but the warning signs of a correction or rotation are building. While equity markets have continued to grind higher, the rise has occurred on low volume and decreased volatility. Against this backdrop, it is interesting to note that large-cap U.S. stocks are beginning to outperform the market.
This is the sort of “rotation” that equity markets tend to engage in when GDP and earnings are gradually moving higher, but are accompanied by very real risks, which in the current environment include: geopolitical tensions involving Iran, another possible round of stress in the eurozone and few expectations that the U.S. will be able to overcome political gridlock to address critical fiscal issues.
In fixed-income markets, investors remain focused on higher-yielding sectors in the belief or hope that economic strength will outweigh the risks posed by higher oil prices and other concerns. Europe’s debt crisis, long the dominant force in driving market performance, has played a lesser role in the past few weeks. Markets have responded favorably to the latest developments in Greece and to the extension of nearly €530 billion in the second offering by Europe’s Long Term Refinancing Operation announced February 29.
Equity and fixed-income markets alike will focus on a number of key economic indicators during the week of March 5, including monthly payrolls and the unemployment rate for February.
The information provided herein is as of March 2, 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.