Asset Management

Markets seek boost amid mixed data, Spanish debt concerns

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

September 28, 2012

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Heading into the final trading day of September, the S&P 500 Index appeared to be on track for a positive month, despite a rocky second half that included a five-day losing streak and negative returns in seven out of nine trading sessions. Overall, the S&P 500 lost more than 1% in the last two weeks of the month, after rising more than 4% in the first two weeks.

Most global equity markets saw a similar dichotomy in returns during the month, correcting from extended levels as investors sold shares in order to book gains before month-end. Market losses were exacerbated by renewed concerns about Europe’s sovereign debt crisis, highlighted by Spain’s precarious fiscal situation and rising debt yields, public protests against austerity measures in Greece and Spain, and potential legal challenges to the European Central Bank’s recently announced bond-purchase program.

Article Highlights

  • Equities end September on an unsettled note, but remain well in positive territory.
  • Demand for safe-haven assets rises as wary bond markets eye Spain’s debt woes.
  • U.S. GDP growth rate is lowered, but employment and housing improve.
  • Outlook for Europe looks brighter in 2013 while China awaits more stimulus.
  • Equity markets have room to rise further as we enter the fourth quarter.

Like equities, most "spread sector" fixed-income products—higher-yielding, non-U.S. Treasury securities—also came under pressure during the past week. An exception was in the mortgage sector, where certain types of securities proved resilient, thanks to continuing purchases as part of the Federal Reserve’s third round of quantitative easing (QE3). Otherwise, a spike in Spanish bond yields to levels above 6%, along with some weak U.S. economic releases, gave investors pause and boosted demand for safe-haven assets such as U.S. Treasuries. As a result, the yield on the bellwether 10-year Treasury security—which had closed as high as 1.88% on September 14—ended at 1.66% on September 27 and was heading lower as the week drew to a close.

U.S. economic data: hits and misses
The past week’s economic releases offered mixed signals to investors seeking evidence of a stronger U.S. recovery. Disappointing indicators included:

  • a downward revision in second-quarter GDP growth, from an already tepid 1.7% to 1.3%, as consumer spending and business investment rose less than originally estimated;
  • a 13.2% drop in orders for industrial goods, led by sharply reduced demand for aircraft and autos; and
  • a decline in the Chicago-area Purchasing Managers Index (PMI) to a level below 50, indicating that the manufacturing sector in this region contracted for the first time in three years.

These weak indicators were balanced by better-than-expected news on the employment front and continued signs of improvement in the U.S. housing sector:

  • The U.S. Labor Department announced that it would upwardly revise its estimate of total employment by about 386,000 jobs, or 0.3%, for the 12-month period from April 2011 to March 2012.
  • First-time unemployment claims fell by 26,000, to a seasonally adjusted level of 359,000—well below consensus forecasts of about 375,000.
  • Home prices, as measured by the Case-Shiller Home Price Index, rose for the fourth consecutive month, reaching a near two-year high.
  • Although new-home sales declined slightly in August, July’s total was revised upward, and the pace of sales was the fastest in more than two years. Overall, new home sales jumped 28% from a year ago, while new home prices climbed 17%.

Also on the positive side, gasoline prices have fallen by 20 cents per gallon over the past three weeks, reflecting the recent drop in oil prices. Meanwhile, consumer spending and personal income in August rose largely in line with expectations.

Spain at the center of latest European debt worries
Markets have widely perceived Spain’s fiscally strapped government as dragging its heels in requesting a formal bailout from EU authorities. Spanish Prime Minister Mariano Rajoy has resisted signing a memorandum of understanding with the European Central Bank (ECB), which would allow Spain to take full advantage of the ECB’s bond purchase program, subject to strict conditions. Late in the week, Prime Minister Rajoy unveiled a 2013 budget that included tax increases, spending cuts and other austerity measures, which temporarily calmed the markets. In addition, results of the latest round of "stress tests" for Spanish banks brought a measure of relief, as the amount of capital needed to shore up ailing banks was generally in line with expectations. Against this backdrop, as of midday on September 28, Moody’s Investors Service was weighing whether to lower Spain’s sovereign credit rating, potentially to below investment-grade status.

Rising consumer confidence in the U.S., uncertainty in China
Rising consumer confidence suggests a somewhat brighter outlook for the U.S. economy. The Conference Board’s index of consumer confidence jumped a remarkable 9 points in August, to its highest level in seven months—a harbinger of potentially stronger consumer spending in the coming quarter. Other measures also point to a more optimistic consumer, including the Thomson Reuters/University of Michigan Consumer Sentiment Index, which hit a four-month high in September, and the Bloomberg Consumer Comfort Index, which rose for a fifth consecutive week. Unfortunately, corporations still seem reluctant to spend, and CEO confidence has moved lower.

In Europe, the economy remains in contraction mode, although the outlook for 2013 has begun to look better. Some GDP growth estimates have been raised, driven by stronger performance by financial markets, falling oil prices and less fiscal tightening. However, Asia in general and China in particular appear weaker. Within China, there is significant debate over whether to implement further policy moves to stimulate the economy. We continue to focus on the trajectory of the Shanghai Stock Exchange “A Share” Index as a signal that stimulus measures are being applied. This index has remained in a downtrend since April 2011, although it jumped more than 2.5% in the past week on news that China’s central bank had injected nearly $60 billion of liquidity into the country’s money markets.

On balance, we think equity markets have room to move higher as we enter the fourth quarter, assuming a correction in overly bullish short-term sentiment sets the stage for such an advance. This view is supported by a number of factors, including seasonal market tendencies, increased Fed liquidity and rising earnings expectations.