Asset Management

Quarter gets off to a shaky start, but there’s cause for measured optimism

David Brown, Head Portfolio Manager, TIAA General Account

Key points

  • Equity and fixed-income markets were rattled by signs of worsening economic and fiscal conditions in Europe, particularly Spain, and by diminished prospects for a third round of quantitative easing by the Federal Reserve.
  • A spike in Spanish government bond yields set the tone for underperformance by “spread” sectors (higher-yielding, non-U.S. government fixed-income securities), while Treasuries benefited from increased demand for safe-haven assets.
  • Despite some areas of concern, including disappointing job numbers for March, overall economic momentum has remained positive in the U.S.

Fears that equity markets would pull back from strong first-quarter performance were realized in the opening days of April, reflecting the combined effects of “tired” technical factors (including fewer new daily highs and lower trading volumes), overly bullish sentiment, a resurgence of eurozone sovereign debt fears and some economic indicators that disappointed.

In particular, recent readings of the Purchasing Managers’ Index (PMI) indicate that U.S. production rates are set to decelerate, that Europe is headed toward recession (or already in one), and that China remains in slowdown mode. Although February’s rise in U.S. consumer spending was the largest in seven months, the boost may have been driven primarily by extremely mild winter weather, which enabled consumers to spend less on heating bills and more on discretionary items. The increase in spending also came at the expense of a significant drop in the personal savings rate. Moreover, real disposable personal income (income after taxes and inflation) fell slightly in January and February, which may portend slower consumer spending patterns later this year.

Overall, however, economic momentum in the U.S. has remained positive—so much so that the minutes from the most recent Federal Reserve meeting indicated no need for further monetary stimulus after the current program of quantitative easing expires in July. This statement disappointed the equity markets, contributing to a 1.02% decline in the S&P 500 Index on April 4, its second-largest one-day drop in 2012 to date. For the week, which was shortened by the Good Friday holiday, the S&P 500 was down 0.7%, while foreign developed and emerging market equities lost 2.8% and 0.4%, respectively, based on MSCI indexes. This shaky start to the second quarter may have a silver lining in that short-term measures of sentiment have quickly retraced from extremely bullish levels, which could help set the stage for another equity market advance.

Fixed-income markets were also unpleasantly surprised by the Fed’s statement regarding quantitative easing. While the Fed’s view that no additional stimulus measures are necessary offers a hopeful assessment of the U.S. economy, investors in “spread” products had generally assumed the Fed would continue to purchase Treasury securities, mortgages or both to stimulate demand and help ensure that the recovery remains on track. With this expectation dampened, prices for investment-grade corporate debt, high-yield bonds and asset-backed securities generally declined, sending their yields higher.

At the same time, European sovereign debt concerns flared up again, adding to a broadly negative tone for spread-sector investments. Spanish and Italian government bond yields spiked on lackluster demand and doubts about the ability of these nations to maintain austerity in the face of weakening GDP numbers. U.S. Treasury yields also climbed early in the week, with the bellwether 10-year note hitting 2.30% on April 3 before drifting back down to 2.19% on April 5 as Treasuries benefited from investors’ preference for safety.

Late in the week, there were decidedly mixed signals on the U.S. employment front. While weekly first-time unemployment claims continued their steady decline, the economy added only 120,000 jobs in March, far below expectations. The unemployment rate dipped to 8.2%, but this was due to more people leaving the workforce and not to expanded hiring. Despite the disappointing jobs data, other indicators offer cause for measured optimism: oil prices are off their March highs, corporate earnings revisions are rising, company surveys of activity remain strong and consumer sentiment has been trending higher.