Asset Management

Market jitters continue as macro developments trump corporate earnings

William Riegel, Head of Equity Investments

Key points

  • Global equity markets remained volatile as financial headlines and key economic indicators continued to alternate from positive to negative and back again. U.S. employment data and the European debt crisis were among investors’ chief concerns.
  • Fixed-income markets also fluctuated between fear and optimism, leaning toward safer, higher-quality sectors at midweek. After a brief respite, Spanish and Italian bond yields resumed their upward climb, while the 10-year U.S. Treasury yield dipped to 1.98%.
  • Despite recent hiccups in U.S. economic data, we maintain a constructive but cautious near-term view on the economy and the equity markets.

After posting a 2% loss the week before, the S&P 500 Index continued its bumpy ride, as anxious investors reacted to the latest batch of U.S. economic data and more debt-related warning signs out of Europe. For the month-to-date through April 19, the S&P 500 declined 2.2%, while foreign developed and emerging-market equities lost 3.1% and 1.5%, respectively, based on MSCI indexes.

For the second week in a row, first-time claims for unemployment benefits were higher than anticipated, raising doubts about the strength of the U.S. jobs recovery. Meanwhile, housing starts and existing home sales for March fell short of forecasts, and homebuilder confidence in April slipped for the first time in seven months — all of which dampened recent optimism about the housing market and its potential to spark faster economic growth.

Tempering the week’s disappointing releases, but not by much, were robust retail sales figures for March and an uptick in the Conference Board’s index of leading economic indicators. Other recent positive signs include increases in steel production and bank loans, and a downtick in commodity prices.

In Europe, bank stocks tumbled and Spanish and Italian government bond yields spiked to worrisome levels during the week, as Italy’s proposed labor reforms were watered down in parliament and Spain projected larger budget deficits due to weaker growth. A well-received auction of Spanish bonds provided a brief respite from surging bond yields on April 18, but fear returned to the markets the following day. In contrast to southern Europe, Germany’s economy has remained strong. The German ZEW, a widely used measure of investor sentiment, climbed in April to its highest level since June 2010, and anecdotal information indicates surging business activity that has prompted some German companies to rely on outsourcing to maintain production levels.

With U.S. and European macro-level concerns dominating the week’s market moves, corporate earnings (an important fundamental driver of stock prices) were somewhat lost in the shuffle. We are still very early in the first-quarter earnings season, but on balance the news has been good, and earnings expectations globally are being revised upward.

A notable result of recent volatility has been a sharp correction in equity market sentiment, which peaked in March at what we considered dangerously bullish levels. In addition, hedge funds are now generally “shorting” the market (betting on a downturn), as evidenced by a decline in their net exposure to the market below a key 50% threshold — a contrarian indicator that historically has often signaled a subsequent market upturn. A monthly industry survey of Wall Street strategists also turned more pessimistic in April, and, given the risk-averse climate, bond fund inflows have surged to record levels.

Against this unsettled backdrop, equity markets are attempting to move higher. We believe conditions are generally supportive of an upward move in the near term, which — if it occurs — will likely favor larger, higher-quality and more growth-oriented companies.