Asset Management

Volatile markets stumble and surge amid mixed economic signals

William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets

Key points

  • Market volatility returned with a splash during the past week, as a worsening five-day slump in equities abruptly reversed course on April 11. Unpleasant surprises in U.S. jobs data and heightened anxiety about Europe and China drove the downturn, while a slight easing of some of these concerns fueled the mid-week rebound.
  • Fixed-income markets also saw their share of gyrations. The recent flight to quality generally continued, favoring U.S. Treasuries, but was punctuated by volatile yields on the bellwether 10-year Treasury note.
  • Rekindled volatility reflects the degree to which investors are seeking direction from daily economic releases. While U.S. employment indicators in particular have been disappointing, in our view they do not represent a fatal blow to hopes of further expansion. On balance, we think the odds favor continued growth, albeit on a slower trajectory.

Equity markets were pressured in the first two weeks of April by several factors:

  • unexpectedly weak U.S. employment data
  • deepening pessimism over Spain’s fiscal plight
  • continued fears of an economic slowdown in China, highlighted most recently by lower-than-forecast first-quarter GDP growth, which cooled to 8.1%, versus 8.9% in the fourth quarter of 2011.

For the month to date through April 10, the S&P 500 Index dropped 3.5%, the MSCI EAFE Index lost 4.5%, and the Russell 2000 Index fell 5.5%. These declines confirmed our expectations of a pullback, given what we perceived to be unsustainable levels of bullish sentiment and technical trading factors that pointed to a “tired” market.

Disappointing monthly payroll numbers for March sparked a sell-off in equities at the start of the past week. Net job creation was at its lowest level in five months at 120,000, sharply below forecasts of about 205,000. Also of concern was a surprising uptick in weekly first-time unemployment claims, to 380,000 — still below the 400,000 threshold that signals weakening job market fundamentals, but also the highest level since January. In addition, claims for the prior week were revised higher.

The sharp drop in equities benefited U.S. Treasury markets and other safe-haven investments. On April 10, as the S&P 500 tumbled 1.7%, demand for Treasuries surged, temporarily driving the 10-year yield below 2% — a remarkable drop, considering the yield had been approaching 2.5% only a few weeks before. Unlike Treasuries, “spread-sector” investments (higher-yielding, lower-rated fixed-income securities, such as commercial mortgage-backed securities and high-yield corporate bonds) realized negative returns early in the week. Meanwhile, in Europe, Spanish sovereign debt yields continued to climb through midweek, as fears about Spain’s fiscal solvency intensified.

Just when it seemed that the markets would extend their malaise, however, investor gloom quickly evaporated. On April 11, the S&P 500 bounced back from the previous day’s steep decline, gaining 0.8% on bargain-hunting and on Alcoa’s optimistic kick-off to first-quarter earnings season.

The S&P 500 followed this rise with an even bigger gain of 1.4% on April 12, amid several developments:

  • a mixed bag of U.S. data (with a welcome narrowing of the trade deficit helping to offset concerns about the jump in weekly jobless claims)
  • a better-than-expected bond auction in Italy (which tempered fears of a further spike in Italian and Spanish yields)
  • an increase in Chinese lending activity in March (suggesting a continued easing of monetary policy given the prospect of a “soft landing” for China’s economy).

In fixed-income markets, Treasury yields drifted back up, with the 10-year yield settling at 2.08% on April 12, only to dip below 2% again during the next day’s trading, as investors reacted to the latest round of economic data.

The recent volatility in Treasury yields and stock returns reflects the degree to which investors are seeking direction from daily economic releases. Although the latest U.S. employment indicators were troubling, in our view they do not represent a fatal blow to hopes of further expansion. Moreover, a number of other economic signals, such as consumer spending and manufacturing, have been supportive. We continue to monitor developments closely, mindful of potential downside triggers. On balance, we think the odds favor continued growth in the near term, albeit on a slow trajectory — and with more fits and starts along the way.