Asset Management

Markets turn more volatile following strong January run

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

February 8, 2013

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Equity markets fluctuated during the first week of February, as investors reacted to a spate of “good news, bad news” headlines. Renewed worries about Europe, fears of a market correction, and a sharpened focus on U.S. consumer sentiment sent stock prices lower, while better-than-expected trade data for the U.S. and China lifted markets late in the week. Despite the heightened volatility, the S&P 500 Index generally stayed at or above the 1,500 level, while total returns remained in solidly positive territory (+6%) for the year to date through February 7.

Article Highlights

  • Equity markets see increased volatility during the week.
  • Investors focus on Europe, a potential market correction, and U.S. consumer confidence.
  • Bonds seek direction amid competing economic and market signals.
  • Narrowing U.S. trade gap bodes well for upward revision to fourth-quarter GDP.
  • China continues to accelerate, while inflationary pressures remain in check—for now.

Increased optimism about the U.S. recovery has helped spur demand for equities in 2013. That said, in recent weeks defensive sectors such as Utilities, Healthcare and Consumer Staples have outperformed cyclical (economically sensitive) sectors such as Technology, Materials and Consumer Discretionary. Meanwhile, foreign developed- and emerging-market equities have been flat to slightly negative since mid-January, lagging their U.S. counterparts.

Fixed-income markets were unsettled during the week, prompting some investors to favor the safe haven of U.S. Treasuries. With the yield on the bellwether 10-year Treasury security dipping below 2%, the “spread” between Treasuries and higher-yielding, non-Treasury securities—including investment-grade and high-yield corporate bonds, mortgage-backed securities (MBS) and commercial mortgage-backed securities (CMBS)—widened. Overall, bond markets have waffled, seeking direction from a mixed bag of signals: generally positive economic news and corporate earnings releases on the one hand, and worries about European debt dynamics and the upcoming U.S. budget sequester on the other.

U.S. economic data still painting a picture of slow, steady growth

Data released during the week did little to sway our view on the U.S. economy. Fundamentals continue to exhibit slow, steady growth, with improvements in some areas stronger than others.

  • December factory orders were mildly positive (+1.8%) for the month but slightly below consensus forecasts and fairly modest (+4.8%) for 2012 as a whole.
  • As measured by the Institute for Supply Management’s nonmanufacturing index, activity in the service sector of the economy was softer in January at 55.2, but still well above the 50 threshold that separates contraction from expansion.
  • Nonfarm productivity declined 2% in the fourth quarter, while unit labor costs increased 4.5%. The rise in unit labor costs was driven partly by steady improvements in hiring and partly by the productivity number, which in turn reflected weak economic performance last quarter. Productivity improvement is key to long-term economic growth, while unit labor costs are an important signal of future inflation. However, both indicators are currently trending sideways, suggesting little inflationary pressure.
  • First-time unemployment claims improved to 366,000, down from a revised 371,000 in the previous week. The four-week moving average, which smoothes out much of the volatility in this number, fell to 350,000. Although the decline is welcome, the moving average has stayed within a tight range for some time, and it will need to fall well below this range, to about 325,000, for a sustained period before we see significant upward movement in monthly employment statistics.
  • Consumer credit expanded for the fifth consecutive month in December, with the increases concentrated in student loan debt and auto financing. Credit card debt was down slightly for the month, but quarterly and annual figures were mildly positive—certainly not at the level needed for sustained increases in consumer spending, but enough to suggest that “deleveraging” (the steady reduction in credit card debt loads that we have seen since the Great Recession) is likely over

Of particular note among the week’s data releases was a dramatic improvement in the U.S. trade deficit, which narrowed from $48 billion in November to $38 billion in December. We expect this will result in an upward revision to fourth-quarter GDP growth, from -0.01% in the government’s advance estimate released on February 1, to somewhere between +0.5% and +1.0%.

Despite the unexpectedly strong improvement in the trade number, the Citigroup Economic Surprise Index has been on a downward track, indicating that economic releases have, by and large, been coming in below expectations. However, a different economic surprise index, published by UBS, has trended sideways for the past month, painting a more neutral picture.

European concerns resurface as politics claim the spotlight

European markets fell early in the week on political news out of Spain and Italy.

  • In Spain, Prime Minister Marino Rajoy was implicated in a scandal that is seen as damaging to his efforts to reform the economy. Meanwhile, the Spanish unemployment rate has continued to climb, and the economy is still contracting, although the most recent Purchasing Managers Index (PMI) showed a slight improvement.
  • In Italy, where elections are scheduled for February 24, controversial former Prime Minister Silvio Berlusconi has gained in the polls. This prospect is unsettling to the markets because Berlusconi has pledged to undo many of the reforms enacted under previous Prime Minister Mario Monti.

Despite the recent negative headlines and ongoing concerns about the region’s long-term debt and fiscal challenges, the overall picture in Europe remains relatively calm compared with a year ago. We see no concrete evidence to suggest a fundamental shift in the broader European economy or financial markets.

Chinese growth continues to pick up, while Japan warms to “Abenomics”

In Asia, China’s economy remained on an upward slope. Indicators such as PMIs, real estate prices, commodity prices, and the Shanghai Stock Exchange “A” Share Index signal accelerating growth. Data released during the past week reinforced the broadly positive tone in the world’s second-largest economy:

  • China’s trade surplus came in at a better-than-expected $29.2 billion in January, with both exports and imports rising sharply.
  • Bank lending soared by 45% in January compared with a year ago.
  • Chinese inflation eased, with consumer prices rising 2% in January (versus 2.5% in December).

In Japan, the stock market surged earlier in the week on continuing speculation that new Prime Minister Shinzo Abe will appoint a central bank chief committed to aggressive monetary policy easing, part of Abe’s stated agenda (now dubbed “Abenomics”) to stimulate growth by weakening the yen and reversing the Japanese economy’s long deflationary spiral. The market fell sharply on February 8, however, partly in response to comments by Japan’s finance minister, who stated that the drop in the yen has been too fast.


While consumer sentiment surveys can be useful tools, they do not always correlate with actual spending patterns. In the U.S., we see an incongruity between declines in some widely cited consumer indexes and signs of healthy retail activity in January, which is typically not a strong month, as old inventory is cleared out. Since last October, monthly readings for The Conference Board’s Consumer Confidence Index and the Thomson Reuters-University of Michigan Consumer Sentiment Index have fallen steadily. In contrast, the Consumer Index published by Rasmussen Reports has trended upward.

While this short-term divergence is notable, over time we put more stock in longer-term trends and believe the readings will likely converge toward the upside as consumers increasingly perceive the benefits of the recovering economy. In our view, real gains in consumer wealth—driven by improving home prices, a rising stock market, better employment conditions, and higher disposable incomes—should offset the impact of higher payroll taxes and gasoline prices.

A full-throttled consumer recovery will be key for the economy to achieve so-called “escape velocity”—a pace of growth that can fuel sustained job creation without direct intervention by the Federal Reserve. Such an outcome is conceivable within the next few years if several factors align: the global economy continues to improve; there are no severe geopolitical shocks to the system; the U.S. housing recovery remains on track; and the policy gridlock in Washington, D.C. eases.

In Europe, the return of uncertainty and higher perceived risks may create potentially compelling investment opportunities, as valuations remain attractive and European economic activity continues to bottom. In Asia, despite continuing good news out of China, there are cross-currents that give us pause. In particular, the Australian dollar, which in previous cycles has strengthened in line with Chinese growth, has dropped sharply. Similarly, the Chinese 10-year bond rate, which historically has spiked when the economy accelerates, has gone flat.

In terms of signaling the trajectory of the Chinese economy, we think these anomalies may prove to be less reliable than the performance of the Shanghai A share market, which remains strong. If that turns out to be the case, materials prices globally may continue moving higher, which could crimp corporate profit margins and—if gasoline prices also rise—affect consumer spending as well. That, in turn, could set the stage for another summer slowdown and falling equity prices in the U.S., such as we saw in 2012 and 2011. While such a development is far from certain, the risk is compounded by the possibility of automatic spending cuts kicking in if Congress fails to reach an agreement and avoid the “sequester.”