by Jason Norris, CFASenior Vice President of Research
Greece Is the Word The week started off with a positive catalyst as the EU and IMF set conditions for the Greek debt restructuring. Unfortunately, if you are a bond holder of Greek debt, you will only receive 46 cents on every $1.00. Despite these returns, we believe this is a good first step in resolving the debt crisis. Now that this milestone has been reached, the European banks will begin to feel the effects of these “adjustments” as major institutions will have to take write downs, such as RBS, Commerzbank and Credit Agricole. Investors are becoming more confident that the EU IMF will collectively resolve the debt issues in Europe as shown by declines in the bond yields in countries, such as Spain and Italy.
Home “in” the Range Yields on the 10-year Treasury have been hovering around 2 percent for close to six months, even as we’ve seen economic improvement in theU.S. The Federal Reserve remains active in the bond market buying longer-term Treasuries to keep rates low and has just announced another $400 billion purchase program. Another large buyer of bonds is theU.S.retail investor. Even as rates have steadily declined the last 12 months, investors continued to pump money intoU.S.taxable bond funds. Over that period of time, investors have poured over $125 billion into taxable bond funds, while redeeming over $168 billion in equity funds. Individual investors are still very skittish about equities; we believe this may be “fuel” for the equity markets as the economy improves and investors become less risk averse.
We Can Work It Out Jobs data showed a steady improvement this week, with weekly unemployment claims dropping to its lowest level since March 2008. This indicator is one we follow closely due to its timeliness. We are also seeing resurgence in manufacturing jobs for the first time since the 1990s. Productivity gains and the increasing cost competitiveness of theU.S. labor force is making domestic manufacturing more appealing.
The jobs picture is going to be key for this election. Since World War II, an incumbent president has not been re-elected with the unemployment rate over 7.5 percent. The most recent report for January was 8.3 percent but does seem to be declining.
Taxman Although the President released his tax overhaul proposal this week, the biggest near-term “tax” and risk to the U.S. economy seems to be gasoline. We have seen a steep increase in the price of fuel over the last couple weeks. The effect this increase will have on spending may be meaningful, especially on the low-end consumer. In the first four months of 2011, gas prices increased 30 percent, resulting in significant negative revisions to U.S. GDP. We remain underweight consumer sectors due to concerns about spending, as well as increasing input costs pressuring margins.
Keep Holding On Even after a 9 percent increase in stocks year-to-date, we believe equities are still attractive. Corporate earnings remain strong and economic growth in the U.S. is improving. The volatility that we anticipated earlier this year has yet to show itself in 2012, but many important policy issues have not yet been addressed that need to be resolved before the end of the year. We continue to focus on large-cap domestic equities with attractive dividends.
Our Takeaway from the Week While stocks may see some near-term profit-taking, we see equities supported by the following:
- improving economic growth
- “under-owned” by individual investors
- low interest rates
- attractive valuations
- continued M&A and share buybacks