William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets
July 13, 2012
Equity markets struggled for much of the past week, with the S&P 500 Index down 1.5% in the first four trading days, and foreign developed and emerging-markets equities losing more than 2% and 3%, respectively, based on MSCI indexes. Investors continued to worry that economic weakness in the U.S. and China, coupled with a recession in Europe, may signal the beginning of a globally synchronized slowdown. On Friday the 13th, however, the release of China’s GDP growth rate for the second quarter — significantly lower than in the first quarter, but no worse than consensus forecasts — sparked a major “relief rally” that put global equity markets on track to recoup their losses from earlier in the week.
In fixed-income markets, global growth concerns continued to drive demand for the safe haven of U.S. Treasuries. The yield on the bellwether 10-year Treasury fell to as low as 1.48% on July 12 before edging back up in the wake of China’s GDP release. Meanwhile, many non-Treasury fixed-income sectors—including U.S. mortgage-backed and commercial mortgage-backed securities, investment-grade and high-yield corporate bonds, and global emerging-markets bonds—have generally held up well in July, despite the prevalent gloom. This reflects, in part, investors’ continuing search for higher yields as the historically low interest-rate environment persists. Investors also recognize that many corporate issuers have low levels of debt and strong cash flows, making their bonds an attractive alternative to lower-yielding Treasuries.
This year’s summer slowdown: similar, but not the same
For the third year in a row, the U.S. economy is decelerating at mid-year, and equity markets reversed course after a strong first quarter. Manufacturing, employment, and consumer confidence levels have clearly weakened, and consensus forecasts of second-quarter GDP growth have been revised downward. While no mainstream economists are predicting a recession at this point, most acknowledge that the current slowdown is significant. Moreover, the global economic backdrop remains bleak.
That said, the current situation differs from those of the past two years in some important respects:
In addition, data released in the second week of July showed pockets of resilience within the broader U.S. slowdown:
Market outlook balances favorable indicators with downside growth risks
The U.S. and global economies remain in slow-growth mode. Notwithstanding the exuberance of the Friday the 13th equity market rally, China’s economy expanded at its slowest pace since the first quarter of 2009. One key indicator of China’s growth trajectory—the Shanghai “A” stock market—has yet to move. A spike would indicate that Chinese authorities are going into full stimulus mode. In the meantime, the potential success of China’s efforts to spur its economy has yet to be determined.
Europe continues to champion economic and fiscal reforms in theory, but has been slow to deliver tangible results, and the eurozone economy remains precarious at best. Interestingly, European stock markets have begun to reflect this reality, with relative valuations on European equities (especially in southern-tier markets such as Italy and Spain) reaching extremely attractive levels.
In the U.S., weak employment is dampening earnings expectations, resulting in negative revisions. Although we are not in a recessionary slide, the economy remains vulnerable to external shocks, such as a potential confrontation between Israel and Iran, and credible scenarios that envision a break-up of the European Union. Nonetheless, we think there is a case to be made for U.S. growth to reaccelerate in the second half of the year, bolstered in part by recent technical trading patterns suggesting an upward bias for stocks, as well as extremely low net hedge fund exposures to equities, a contrarian indicator that historically has proven bullish for U.S. equity returns.
The information provided herein is as of July 13, 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.
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