Asset Management

Surprisingly strong jobs report caps an otherwise quiet week

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

December 7, 2012

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U.S. equity markets were relatively calm for most of the past week. Although the fiscal impasse in Washington remained center stage, there was little movement in negotiations to sway markets in one direction or another. The S&P 500 Index traded in a fairly narrow range, returning -0.1% for the week through Thursday, Dec. 6. Friday morning’s release of surprisingly strong payroll numbers for November—and a drop in the unemployment rate to a four-year low—sparked an initial rally, but this appeared to be losing steam by midday.

While U.S. stocks were in a holding pattern, European and emerging-market equities broke out to 18-month highs during the week, based on MSCI indexes. In Europe, markets were supported by:

  • a further reduction in risks associated with a potential breakup of the Eurozone
  • falling yields on sovereign and corporate bonds, and
  • data showing a stabilizing of economic activity, rather than a worsening decline.

Article Highlights

  • November payrolls surge despite Hurricane Sandy; unemployment down to 7.7%.
  • Economic data continue to support U.S. growth trajectory, but caveats remain.
  • U.S. equities trade in fairly narrow range, lagging Europe and emerging markets.
  • Fixed-income markets are mixed as investors digest data and eye fiscal cliff.
  • Given short-term “noise” and fiscal unknowns, greater clarity may not emerge until first quarter of 2013.

In emerging markets, economic conditions continued to improve, evidenced in part by favorable Purchasing Managers Index readings (PMIs) relative to developed markets. (Monthly PMIs gauge whether manufacturing and/or service-sector activity is expanding or contracting, based on various criteria.)

Fixed-income markets vary in response to fiscal and economic news

U.S. Treasury yields drifted lower for most of the week, reflecting uncertainty regarding the fiscal cliff. The yield on the bellwether 10-year security closed at 1.59% on Dec. 6 but ticked up again in the immediate wake of the November employment report. Results were mixed in higher-yielding, non-Treasury “spread” products, with investment-grade corporate bonds underperforming their high-yield counterparts. Emerging-market bonds, commercial mortgage-backed securities, and asset-backed securities were relatively stable.

The spread between investment-grade corporate yields and Treasury yields widened, in large part because corporate issuers have been rushing new offerings to market, seeking to avoid the potential volatility leading up to — and following — the Dec. 31 fiscal cliff deadline. Although inflows to corporate bond funds have recently been supportive of narrower spreads, the volume of new supply has become too much for the markets to fully absorb. Meanwhile, high-yield bonds have continued to perform well, as investors remain willing to take on higher credit risk, particularly as the Federal Reserve continues to support economic growth through ongoing asset purchases.

Despite dramatic employment report, no “game changers” in U.S. economic data

November’s employment report showed the U.S. economy adding 146,000 jobs last month — nearly twice the number expected, according to consensus forecasts. Job creation varied by sector: Retail and other service sectors showed gains, while manufacturing and construction employment fell. Temporary hiring rose, as is to be expected with holiday shopping season under way. Meanwhile, the unemployment rate fell from 7.9% to 7.7%, contrary to expectations that it would remain unchanged or even tick up.

Although these headline numbers represent welcome news, the extent to which they defied expectations underscores the challenge of predicting how the anticipated impacts of Hurricane Sandy will filter through the economy. We may see continued volatility or “noise” in employment and other economic data before clearer trends emerge.

In the meantime, most economic releases during the week essentially confirmed the moderate U.S. growth trajectory.

  • First-time unemployment claims fell for the third consecutive week, to 370,000 from a revised 395,000 the previous week, while continuing claims (representing the number of people already receiving regular unemployment benefits) declined by 100,000.
  • Construction spending climbed 1.4% in October, fueled by homebuilding activity.
  • Auto sales posted another strong month of gains, reflecting resilient consumer demand and the likely impact of replacement purchases for vehicles destroyed by Sandy.
  • Factory orders rose 0.8% in October, a potential indicator of renewed resilience in the manufacturing sector.
  • The service sector expanded for the 35th consecutive month in November, based on the monthly services index published by the Institute for Supply Management (ISM). At 54.7, the index level remained above the 50 threshold that separates growth from contraction.

On the downside, ISM reported that its manufacturing PMI dipped to just below 50 (49.5) in November, while the Thomson-Reuters/University of Michigan index of consumer sentiment tumbled unexpectedly in December, after four months of gains.

Europe stabilizes but remains in recessionary mode

Although much of Europe is now in recession, the past week brought some signs of stabilization in the regional economy: improved retail sales in Germany, firmer consumer confidence, and benign inflation on a year-over-year basis. The eurozone will likely end the year with significant issues still unresolved, but the current level of economic and market sentiment is a testament to the progress made during the course of 2012.

China’s continued improvement reflected in equity market rise

In China, economic activity improved for the third consecutive month, as measured by the HSBC composite PMI, which rose to 51.6 in November, from 50.5 in October. These signs of improvement, combined with increased market confidence that China’s new leadership will pursue supportive economic policies, helped the Shanghai Stock Exchange “A Share” Index rebound by more than 4% during the week.

Outlook: U.S. economy is on track, but potential wrinkles remain

We believe the U.S. economy will continue its modest rate of recovery, with the caveat that Hurricane Sandy’s impact and the fate of fiscal cliff negotiations may be disruptive. Short-term anomalies and distortions in economic data are likely. A mild winter would be a positive in accelerating the economic impact of rebuilding from Sandy; colder weather could delay this impact well into 2013. Meanwhile, concerns about the fiscal cliff may continue to inhibit business expenditures and hiring.

In our view, U.S. equity markets may be positioned to perform well heading into year-end. U.S. corporate profits climbed in the third quarter on higher productivity, and we see a pattern of positive earnings revisions for S&P 500 companies. Emerging-market equities are also beginning to look increasingly attractive based on positive earnings trends. If inflation remains benign, profits could rise even more, potentially driving markets higher.

In fixed-income markets, it is debatable how much further Treasury yields can fall. If we were to arrive at the New Year with no progress in sight, it would not be implausible to see the 10-year and 30-year yields drop to new record lows. As for corporate bonds, we expect new issuance to slow as we approach year-end. Even so, it will likely take a month or so before markets are able to digest the supply of bonds to the point that spreads tighten relative to Treasuries.