William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets
June 29, 2012
During an eventful week that included a much-anticipated European summit meeting, an important Supreme Court healthcare ruling and a number of significant economic releases, global equity markets staged a late-week recovery that more than offset earlier declines. Low expectations for progress in addressing European debt issues were abruptly revised following the announcement of plans agreed upon during the European summit meeting. These include the use of eurozone bailout funds to directly aid troubled banks, plans to purchase sovereign debt in Spain on equal terms with existing bond holders, and common regulatory oversight of European financial institutions. The announcement led to a sharp reduction in Spanish and Italian government bond yields, which had been viewed as approaching unsustainable levels, as well as a dramatic rally in equity markets.
All eyes on the European summit
Taking center stage for the week was the European summit meeting that took place on June 28 and 29. Sharp market declines on Monday signaled investors’ shrinking expectations for far-reaching measures that might include the issuance of common eurozone bonds or other more immediate means to address the mounting funding issues faced by Spain, Italy and other highly indebted European nations. Investors were taken by surprise on Friday by an announced agreement to create a single supervisor to oversee eurozone banks and to use Europe’s rescue fund – the European Stability Mechanism (ESM) – to directly assist troubled banks. Although ESM funding will not be implemented until the end of the year at the earliest and may not be adequate to fully address required funding needs, the plan represents an important intermediate step and indicates increased willingness to share the debt burden among European countries. The move could well be an important pivot point marking a transition from extreme bearishness to a more optimistic outlook for Europe.
U.S. economic releases point to continuing slowdown
U.S. economic releases during the week provided both positive and negative signals, but on balance pointed toward continued weakening and vulnerability to the slowdown gripping Europe.
Most encouraging were indications of an uptrend in housing markets, including:
However, despite an increase in durable goods orders and a better Chicago Institute for Supply Chain Management report, which represented a reversal from two previous monthly declines, manufacturing activity appears to be slowing. In addition, lower consumer confidence, flat consumer spending and corporate earnings revisions that continue to slant negative reflect growing macroeconomic concerns and reduced demand from Europe. Meanwhile, continued slowing in China’s economy has driven sharp declines in oil, copper and other commodities.
Given the clearer signs pointing toward economic slowing, many now will look to Ben Bernanke’s attendance in late August at the Jackson Hole conference for a possible announcement that could signal another round of Fed quantitative easing, perhaps in September.
Supreme Court upholds healthcare law
On Thursday, the Supreme Court voted to uphold key provisions of the Affordable Care Act. The healthcare legislation signed into law in 2010 by President Barack Obama requires U.S. citizens to carry health insurance or pay a tax penalty.
This ruling will likely impact certain healthcare sector securities much differently than others:
While the ruling has resulted in short-term volatility, the market may benefit from improved investor sentiment based on the removal of a significant unknown factor that has been weighing on the sector.
Yields remain at low levels but begin to reflect reprieve from European concerns
In fixed income markets, concerns over Europe drove yields on ten-year and thirty-year Treasury bonds lower through Thursday, while reversing course on Friday. Spreads on investment-grade and high-yield bonds have been fairly stable and remain largely dependent upon developments impacting Europe.
The extension of the Fed’s Operation Twist and the increased likelihood of another round of quantitative easing may have implications for certain fixed income sectors, particularly for lower-coupon mortgage-backed securities, which have been the target of previous Fed purchase and could likely be the target of future purchase programs.
As reflected in the sharp uptick in equity markets following announced plans for improved mechanisms to address Europe’s debt crisis, investors are eager to view developments in a positive light despite risks that remain. When expectations for improvement and market valuations have been reduced to low levels, as they have recently, modest positive developments can easily lead to a reduction in fear, better growth and higher financial markets. However, that optimistic hope is tempered by the very real slowing of U.S. activity, which we are monitoring closely.
The information provided herein is as of June 29, 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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