April 2012 Market Outlook
We commented in January that “we expect the continued, gradual growth rate of the US (2%-3%) to support an ultimately improved investment climate domestically—but we are convinced we will remain in a low-return environment…” The troubling issue for us as investors now is that we continue to be convinced that both parts of that statement remain true, and yet most major domestic equity indexes finished up the first quarter in (or near) double-digit return territory.
We think economic data released within the last two months is more of a “mixed bag” than what has been reflected in the markets—particularly in the month of March. This leads us to conclude that much of the 12% upward thrust of the S&P 500 through Q1 this year was driven by investor sentiment rather than hard evidence, and we expect follow-up economic news in the quarter ahead to disappoint. Note that investor sentiment is a fickle thing. In fact the data has already begun to suggest that GDP forecasts will likely begin to be revised down towards the lower end of the 2%-3% range mentioned in January. Consider these recently reported facts:
The March unemployment report was a disappointment. Like last November’s report, while the overall unemployment rate fell (from 8.3% to 8.2% in March), the number of people actively looking for work—the labor pool—shrank as well. A shrinking denominator in the unemployment ratio renders the ratio itself less relevant. We think this was largely ignored by the markets (and media) last December, but less so this month. We would attribute a perceived lower unemployment rate as a big component of investor sentiment.
Industrial Production (as measured by capacity utilization) has been flat for the last two months. This is generally a highly visible indicator of manufacturing output, and a leading indicator of manufacturing growth within the economy. We actually noted the growth in this number in our October Outlook as a reason to be more optimistic than the general sentiment at that time. It is possible that easing global demand is finally taking a toll on US manufacturers. Two flat months do not make (or reverse) a trend, of course, but we will view this monthly indicator with interest in the near-term.
Much has been made this year about the unusually mild winter weather we have experienced nation-wide, and particularly in the Northeast. Soft housing start figures over the last two months, and particularly in March, despite this benign weather are concerning. In fact housing starts through March are over 8% lower than they were at the beginning of the year.
Certainly none of the points made above signal an imminent recession—or even guarantee softer GDP numbers ahead. However, neither do they jibe with double-digit Q1 stock returns, in our view. We expect meaningful market correction in the near term if domestic economic and employment data does forecast growth with less ambiguity in the coming months.
EUROPE:
No news is good news as it relates to the European fiscal woes of the last few years—and for most of the first quarter this year there was a comparative lack of news (therefore “good news”) pertaining our largest trading partner. The implementation of the LTRO (Long Term Refinancing Operation) in December and its subsequent second-round funding last month have been credited with tamping down concerns (and volatility) related to the immediate issues within the EU peripheral countries. We’ll accept that as far as it goes—but the problem is that it doesn’t go nearly far enough. LTRO is a short term mechanism to deal with liquidity issues, and does not address any of their underlying solvency issues—issues which actually threaten the union itself. As such, our concern is that given the relative size of the economies of Italy and Spain (relative to Greece, that is) additional bail-outs could require enormously greater sums than have been rendered to LTRO to-date. And additional bail-outs will be necessitated by the judgments of market participants (including sovereign, private, foreign and domestic bond holders) on local politics, “austerity measures” and their growth implications, as well as the prospects for better risk/reward trade-offs elsewhere. Our belief is that these forces will test European resolve once again this summer. While investors may have become somewhat more accustomed to the volatility—the stakes are higher with the economies now in focus.
OIL; Global Implications
A year ago we drew a connection between the Fed’s long-term easy-money policy and the rising price of oil, surmising that higher oil prices as a “tax” on economic growth alleviated the Fed’s concern about inflation prospects given the more optimistic economic growth hopes of last spring. As it turned out, other factors acted to curb US growth, and therefore inflation prospects. Surveying the global economic landscape today, we are less optimistic that current oil prices (~$103 WTI, ~$120 Brent) accurately reflect global economic demand for the remainder of this year. Handicapping geopolitical confrontation in the Gulf is beyond the scope of our analytical input, and we have already noted the premium this tension commands per barrel oil in previous Outlooks. Our anticipation is that without continued high-intensity rhetoric (and low intensity military posturing), this premium will dissipate. Coupling this dynamic with lower global demand could result in meaningfully lower oil prices ahead. The upshot of this, of course, would be a mitigating effect on many of the economic pressures previously mentioned in this paper.
We also have lower pricing expectations of other economically sensitive commodities, particularly industrial metals.
BONDS:
As we wrote last summer, a stopped clock is right twice a day. There remains, (in our view) no mathematically justifiable reason for investors to keep piling money into “safe-haven” bonds like Treasuries. But then again, we’ve held this view for some time, and there’s no denying that Treasuries ended up 2011 with very impressive returns yet again, due primarily to European-inspired panic starting last summer. This year’s interest rate and bond return records looks eerily similar to last year’s at this time. We are out of the interest rate prediction business, but we continue to recommend a “barbell” approach to bond portfolio allocations, with short-term corporate high-grade emphasis on one end, and high yield and emerging market sovereign debt on the other.
“Sell in May, Go Away” is the infamous Wall Street saying. As outlined, CCR Wealth Management believes a more difficult near-term is in store for investors based simply on economic fundamentals. While it is possible most investors have become accustomed to market volatility given the experiences of the last several years, we note that there remains an enormous amount of liquidity in the markets given the Fed’s continued easing policies. As we pointed out in January, this can have an accelerating effect on volatility, particularly when ignited by external (i.e. non-fundamental) forces. In short, while we don’t think an absolute repeat of 2011 (Q2 and Q3) is likely, investors would do well to prepare for something close to it.
