William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets
July 6, 2012
U.S. equity markets ended the second quarter with a bang, with the S&P 500 Index surging 2.5% on June 29 on unexpectedly positive news out of the month-end summit of European Union (EU) leaders. During the holiday-shortened first week of July, markets drifted amid relatively light trading volumes but came under pressure late in the week as relief over Europe gave way to deepening concerns about flagging growth in the U.S. and China. These concerns were aggravated on July 6 with the release of June’s weaker-than-forecast U.S. employment numbers.
Bond markets were uneventful for much of the week. The daily closing yield on the 10-year U.S. Treasury continued to hover between 1.60% and 1.65%, a range that has generally held for the past four weeks. Other fixed-income sectors, including investment-grade corporate bonds, also traded in a narrow range. Investors appeared to be waiting for further cues following sizable gains by lower-rated, higher-yielding “spread” sectors on the last day of June. Like equity markets, these fixed-income sectors had rallied on the EU announcement of centralized bank supervision and the future ability to recapitalize struggling eurozone banks directly. Fixed-income markets remain hypersensitive to the European debt situation but have also begun to focus on worrisome U.S. economic indicators—evidenced by increased demand for safe-haven assets, which drove the 10-year Treasury yield lower immediately following the tepid June jobs report.
Another mixed bag of U.S. economic data keeps markets in check
U.S. data releases during the week continued to paint a picture of an economy that is still growing, but at a markedly slower pace than it had been earlier in the year. Among the mixed economic signals:
Signs of global slowdown lead to further central bank easing
On July 5, major central banks took additional steps to help avoid a synchronized global slowdown precipitated by economic weakness in Europe, the U.S. and China.
China in the spotlight
China’s decision to cut interest rates was not unwelcome news in its own right, but it conveyed a sense of urgency on Beijing’s part and fueled speculation that the deceleration of the world’s second-largest economy is worse than originally thought—an ominous sign for the trajectory of global growth. A spate of Chinese economic data to be released during the week of July 9 will provide greater clarity, building on indicators and forecasts issued in the past week, including:
Economists’ median forecast for second-quarter Chinese GDP growth came in at 7.6%, which would be the worst performance for China’s economy since the depths of the 2008-2009 financial crisis. Weaker investment spending, factory output and retail sales were cited as key drivers of the likely slowdown in the broader economy.
Outlook calls for slow growth at best
From a macroeconomic perspective, the near-term outlook appears mixed to negative. Recent strengthening in the U.S. housing market has yet to translate into accelerated jobs growth and a more robust expansion of the broader economy. Although the late June EU summit offered tangible hope that a worst-case scenario in the eurozone may be avoided, further steps toward fiscal integration are still needed, and the regional economy remains precariously close to falling deeper into recession. If forthcoming data out of China confirm a worse-than-anticipated slowdown there, the likelihood of a global recession will increase, regardless of European policy moves. Overall, it is difficult to project anything more than a slow-growth global economic environment as we enter the third quarter.
Against this uncertain backdrop, companies continue to hoard record amounts of cash, while some firms that rely in part on sales from Europe and China are casting an anxious eye toward those markets. Companies that have recently missed targets have tended to sell off aggressively, which raises a caution flag for the upcoming earnings season. In the meantime, the S&P 500 Index continues to trade below its historical average price-to-earnings (P/E) ratio, suggesting that stocks are attractively valued and may offer selective long-term investment opportunities.
The information provided herein is as of July 6, 2012.
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