William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets
January 11, 2013
U.S. equity markets continued their New Year’s climb during the past week. For the month to date through January 10, the S&P 500 Index was up 3.3%. With fiscal cliff urgency in the rearview mirror (at least temporarily), little new economic data to digest, and fourth-quarter earnings season just getting under way, trading volumes were relatively light.
Foreign developed- and emerging-market equities have also been on the rise in January, based on MSCI indexes, reflecting both relief that a U.S. cliff disaster was averted and optimism about the global economy.
In fixed-income markets, select “spread” products (higher-yielding, non-U.S. Treasury securities) continued to rally during the week, with commercial mortgage-backed securities (CMBS) taking the lead. Investor demand has driven CMBS prices up and yields down.
Both investment-grade and high-yield corporate bonds also rallied, but gains were tempered as heavy new issuance made it challenging for the markets to absorb the increased supply. The yield on the bellwether 10-year Treasury, although elevated from late December levels, remained relatively flat during the week, hovering around 1.90%.
A quiet week for U.S. economic data, but growth trajectory remains intact
The past week was marked by a relative lack of economic news. The data that was released generally indicated that the economy continues on its current growth path:
On Friday, January 11, the Commerce Department announced that the U.S. trade deficit widened significantly in November, disappointing economists who had forecast a narrowing of the gap.
Beyond the data released in the past week, we see additional support for continuing improvement in the U.S. economy:
More signs of stabilization in Europe
The eurozone remains in mild recession territory, and unemployment rose to a record-high 11.8% in November, up from 11.7% in October. Nonetheless, the region continues to exhibit some favorable signs:
In addition, market fears related to Europe’s sovereign debt and fiscal challenges have receded somewhat, reflected in Spanish and Italian 10-year bond yields that are roughly 250 basis points (2.5%) lower than their July 2012 peaks.
China’s economic landscape still brightening
Recent data out of China confirms accelerating economic activity:
An unfortunate byproduct of this economic strengthening is a rise in Chinese interest rates, as well as a sharp increase in food prices, which has led to speculation that China’s central bank may begin to tighten monetary policy far sooner than the market currently anticipates. Prices for real estate, steel and iron ore have also risen.
Outlook: Steady growth pattern ahead, with some risks in the coming months
We believe the U.S. economy remains on track for growth of approximately 1.5% in the fourth quarter of 2012. So far, the fiscal drag on growth resulting from the fiscal cliff deal appears to be in line with our expectations. The likeliest scenario for the next round of fiscal negotiations is some form of compromise (but not a “grand bargain”) in which stimulus measures sought by President Obama are roughly offset by spending cuts advocated by Congressional Republicans, along with an agreement to pursue an overhaul of the tax code. The debt ceiling debate, which will heat up in late February, is a potential trigger for a market correction.
Meanwhile, despite recent progress, Europe remains a source of concern. A number of potential negative catalysts may come to bear in the coming months, including:
Any one of these risk factors could lead to higher interest rates in Europe. This would raise borrowing costs for fiscally challenged eurozone governments and increase the need for the European Central Bank (ECB) to purchase bonds through its OMT (Outright Monetary Transactions) program.
Although intermediate-term negative triggers are a risk in both the U.S. and Europe, long-term factors remain positive. These include:
Overall, while equity markets remain vulnerable to a short-term correction because of an extended upward trading pattern and rising optimistic sentiment, the broader backdrop is sufficiently positive that we expect the market to move higher in the near term. However, we would caution that the fiscal and debt ceiling debates remain a sizable wall to climb.
In fixed-income markets, 2013 is shaping up to be a year in which bargains will be hard to come by. To succeed in such an environment, bond investors may need to take a more tactical, active approach to asset allocation, while also focusing on individual security selection. Picking the right bonds in a particular sector will become even more important as the year wears on, as yields in most fixed-income classes remain at or near record lows.
In general, it appears that Treasuries may turn out to be a less rewarding investment than they have been in recent years. We think Treasury yields will rise in the near term as the U.S. continues to put up reasonably strong economic numbers, fall as we approach the March 1 debt ceiling deadline, and perhaps rise again should we get through the process with our nation’s credit rating intact—in our view, a very likely outcome.
The information provided herein is as of January 11, 2013.
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.
TIAA-CREF Asset Management provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®). Teachers Advisors, Inc., is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). Past performance is no guarantee of future results.
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