« Back to Comments and Observations list
* 60% All Country World Index/40% Barclays Aggregate
2012 has gotten off to a nice start with the S&P 500 returning +4.53% in January, more than double the return posted for the full year of 2011. The besieged European markets also participated in the flurry driven by more aggressive ECB policy measures (and actually outperformed the S&P 500 for the month). Emerging markets were the clear standout, as the MSCI Emerging Market Index returned close to double digits for the month, bouncing back from a difficult 2011 that saw the index down -18.42%.
So what drove the rapid reversal? As we noted in last month’s commentary, investor expectations have come down sharply, driven by concerns around the European debt crisis and the pace of economic growth. This set the stage for a rally should the pessimism prove overdone. We saw that play out in January.
Despite a weaker-than-expected fourth quarter GDP report, the domestic economy continues to expand, albeit at below trend levels. Job growth appears to be on the upswing as evidenced by the trend in declining weekly jobless claims. Income growth is showing signs of acceleration. Beleaguered sectors of the economy such as housing and construction are also showing signs of life and auto sales are running at their briskest pace in nearly four years. Not too bad for an economy that was expected to double-dip a mere 3 months ago. Thankfully, headlines out of Europe are also having less of an impact on daily market fluctuations, perhaps suggesting that the more dire outcomes are reflected in current market prices.
All of this has led to a VIX (a proxy for implied market volatility) that is currently trading near six month lows. While it is certainly nice to have a respite from the sharp market movements experienced late last year, it also brings into the question…are investors becoming too complacent? One needs to look no further than the Fed’s recent statement following the FOMC meeting to understand that many challenges lie ahead. By extending their pledge to keep the federal funds rate at historic lows well into 2014, they are certainly not jumping on the sustained economic expansion bandwagon. In fact, yields on Treasury securities are flirting with all-time lows, suggesting that fixed income investors are taking a decidedly negative view on future economic growth prospects.
It is unlikely that the dichotomy between historically low Treasury yields and burgeoning economic activity will last for long. Either equity investors are too bullish on future growth prospects or fixed income investors are headed for a rude awakening. The resurgence in gold prices suggests that the liquidity spigots have once again been turned on full throttle. Central bankers around the globe have shifted to a more aggressive monetary stance as evidenced by a series of cuts in policy rates, coupled with the Fed’s extension of zero interest rate policy and liquidity provisions. We are also seeing a spike in commodity prices, particularly industrial metals, suggesting a more favorable demand environment going forward. With little room for further price appreciation given the low level of absolute yields, volatility may shift to the fixed income markets if economic growth accelerates.
How might this occur? According to the Investment Company Institute, retail investors liquidated roughly $134 billion of domestic equity mutual funds in 2011, while purchasing roughly $125 billion of fixed income mutual funds. From 2007 through the end of last year, retail investors liquidated roughly $469 billion of domestic equity funds and purchased $884 billion of fixed income mutual funds. This near $1.35 trillion swing out of equities and into fixed income instruments represents an enormous source of selling pressure should rates begin to move higher from these historic lows.
While the above is not likely to occur overnight, one must be aware that significant downside exists in the fixed income markets given the asymmetric risk-return tradeoff we are now experiencing.
This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but CAPROCK makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns.
January Market Commentary
Wednesday, Feb 1, 2012 Global equity markets rallied sharply in month of January, as European debt fears took a back seat to improving domestic economic fundamentals and attractive equity valuations. Interestingly, fixed income markets also generated positive gains as investors snapped up Treasury securities in response to dovish remarks out of the latest Fed meeting. Market performance for the month is summarized in the following table:| Index | January |
YTD | Index | January |
YTD |
| S&P 500 (Total Return) | +4.53% | +4.53% | All Country World Index (Net) | +5.48% | +5.48% |
| MSCI EAFE (Net) | +4.92% | +4.92% | Barclays Aggregate | +0.72% | +0.72% |
| MSCI Emerging Markets (Net) | +9.88% | +9.88% | 60/40 Blend* | +3.58% | +3.58% |
2012 has gotten off to a nice start with the S&P 500 returning +4.53% in January, more than double the return posted for the full year of 2011. The besieged European markets also participated in the flurry driven by more aggressive ECB policy measures (and actually outperformed the S&P 500 for the month). Emerging markets were the clear standout, as the MSCI Emerging Market Index returned close to double digits for the month, bouncing back from a difficult 2011 that saw the index down -18.42%.
So what drove the rapid reversal? As we noted in last month’s commentary, investor expectations have come down sharply, driven by concerns around the European debt crisis and the pace of economic growth. This set the stage for a rally should the pessimism prove overdone. We saw that play out in January.
Despite a weaker-than-expected fourth quarter GDP report, the domestic economy continues to expand, albeit at below trend levels. Job growth appears to be on the upswing as evidenced by the trend in declining weekly jobless claims. Income growth is showing signs of acceleration. Beleaguered sectors of the economy such as housing and construction are also showing signs of life and auto sales are running at their briskest pace in nearly four years. Not too bad for an economy that was expected to double-dip a mere 3 months ago. Thankfully, headlines out of Europe are also having less of an impact on daily market fluctuations, perhaps suggesting that the more dire outcomes are reflected in current market prices.
All of this has led to a VIX (a proxy for implied market volatility) that is currently trading near six month lows. While it is certainly nice to have a respite from the sharp market movements experienced late last year, it also brings into the question…are investors becoming too complacent? One needs to look no further than the Fed’s recent statement following the FOMC meeting to understand that many challenges lie ahead. By extending their pledge to keep the federal funds rate at historic lows well into 2014, they are certainly not jumping on the sustained economic expansion bandwagon. In fact, yields on Treasury securities are flirting with all-time lows, suggesting that fixed income investors are taking a decidedly negative view on future economic growth prospects.
It is unlikely that the dichotomy between historically low Treasury yields and burgeoning economic activity will last for long. Either equity investors are too bullish on future growth prospects or fixed income investors are headed for a rude awakening. The resurgence in gold prices suggests that the liquidity spigots have once again been turned on full throttle. Central bankers around the globe have shifted to a more aggressive monetary stance as evidenced by a series of cuts in policy rates, coupled with the Fed’s extension of zero interest rate policy and liquidity provisions. We are also seeing a spike in commodity prices, particularly industrial metals, suggesting a more favorable demand environment going forward. With little room for further price appreciation given the low level of absolute yields, volatility may shift to the fixed income markets if economic growth accelerates.
How might this occur? According to the Investment Company Institute, retail investors liquidated roughly $134 billion of domestic equity mutual funds in 2011, while purchasing roughly $125 billion of fixed income mutual funds. From 2007 through the end of last year, retail investors liquidated roughly $469 billion of domestic equity funds and purchased $884 billion of fixed income mutual funds. This near $1.35 trillion swing out of equities and into fixed income instruments represents an enormous source of selling pressure should rates begin to move higher from these historic lows.
While the above is not likely to occur overnight, one must be aware that significant downside exists in the fixed income markets given the asymmetric risk-return tradeoff we are now experiencing.
This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but CAPROCK makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns.
