Asset Management

U.S. jobs data and Europe’s economy send markets lower

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

Key points

  • After posting modestly negative returns in April, equity markets continued to struggle in the first week of May, largely on weak U.S. employment reports and more data confirming a recession in Europe.
  • Bonds outperformed stocks last month and in the early days of May, led by longer-term U.S. Treasuries, which gained on strong investor demand for high-quality assets.
  • Conflicting signals on the U.S. economy have created a "tug of war" between fear and optimism in the markets, with investors becoming increasingly reactive to daily headlines.

April marked the first down month for equity markets in 2012, with the S&P 500 Index returning -0.63%, after climbing nearly 13% in the first quarter of the year. Foreign developed and emerging equity markets also turned negative in April, returning -1.96% and -1.20%, respectively, based on MSCI indexes.

Bonds generally outperformed stocks in April, and higher-quality bonds in particular realized strong gains. The 20+ year sector of the Treasury market, for example, returned 4.66% in April, outpacing the 1.05% return of U.S. corporate high-yield bonds and the 1.26% return of global emerging market bonds, based on Barclays indexes.

Mixed U.S. economic signals, a prevailing market theme last month, continued in the first week of May. The release of April’s monthly payroll figures and unemployment rate capped a week in which equity markets remained susceptible to sizable swings in reaction to daily doses of conflicting data. Optimism fueled by robust auto sales, a healthy read on U.S. manufacturing activity based on the ISM Purchasing Managers’ Index (PMI), and an encouraging drop in first-time jobless claims was countered by fear driven by slowing job growth and weaker-than-expected growth in the service sector of the economy.

Ups and downs in fixed-income markets
Fixed-income markets also fluctuated during the week. The rise in the manufacturing PMI was welcomed by "spread" sectors (higher-yielding, lower-rated securities relative to U.S. Treasuries), which tend to benefit when the economy is expanding at a healthy pace. Meanwhile, Treasuries generally sold off immediately following the PMI release, as investors concluded that the stronger growth signaled by a rising PMI could lead the Federal Reserve to become less accommodative in maintaining its low-interest-rate policy.

Weak employment reports, on the other hand, were a disappointment to spread sectors of the market and a boon to Treasuries. The yield on the 10-year Treasury, which began the month of April at 2.22% and fell to 1.95% by month’s end, continued to edge lower in the wake of the most recent jobs data.

Evidence of softening U.S. economic activity in April and early May have been compounded by renewed stress in Europe, where Spain has officially fallen into recession, joining seven other eurozone nations (Belgium, Ireland, Italy, the Netherlands, Portugal, Greece and Slovenia) that have seen negative GDP growth for at least two successive quarters. A continued lack of clarity about the China’s growth prospects is also a concern.

Making sense of mixed economic data a challenge
We continue to weigh signs of economic risk against a number of positive signals, including the brightening outlook for the U.S. housing market and continued strength in the manufacturing sector. Interpreting the mixed bag of recent data poses challenges, in part because of unusual seasonal factors, such as very warm winter weather, which may have skewed U.S. job growth higher earlier this year. As a result, financial markets remain uncertain as to whether further deceleration is likely, or whether more benign scenarios will unfold as volatile data begins to normalize. In such an environment, we would caution against drawing hasty conclusions and veering from long-term investment strategies based on what may be short-term "noise" in the markets.

Moreover, although perceived risks may be high, risk premiums in the equity market are higher. Compared to most bonds, equities appear relatively cheap, and sentiment indicators have returned to mildly bullish or neutral levels. This lends support to our view that equities can move higher through the summer, likely led by large-cap, high-quality growth names, whose less-volatile risk profile tends to find favor in uncertain economic environments.

Within fixed-income markets, corporate bond risk remains at fundamentally attractive levels in our view, given that earnings have generally been robust and ahead of estimates, debt levels are low, and cash positions are high by historical standards. Confidence among retail and institutional investors is still strong, with flows into both high-yield and investment-grade funds continuing to trend positive.