WILLIAM RIEGEL, CHIEF INVESTMENT OFFICER
April 3, 2015
Global equities meandered amid light trading in a week shortened by the Good Friday holiday, as investors were cautious prior to the April 3 release of March’s U.S. employment report. March 31 marked the end of a volatile first quarter for the S&P 500 Index, which rose just 1.0% for the period, compared to 18.5% for eurozone stocks (in local terms, according to the MSCI index). For U.S. investors, the dollar’s sharp appreciation versus the euro trimmed that gain to 5.20%.
Japan’s Nikkei 225 Index rallied during the week and returned about 11% (in both local and U.S. dollar terms) for the first quarter, with purchases by pension funds and the Bank of Japan propping up share prices. In spite of this strong performance, we remain somewhat skeptical of future gains in Japan’s equity markets.
Treasuries had been moving in a narrow range before the March jobs report sent their prices up and their yields down. (Price and yield move in opposite directions.) In mid-day trading on April 3, the yield on the 10-year Treasury, which began the week at 1.95%, had dropped to 1.84%, a two-month low. “Spread products” (higher-yielding, lower-rated non-U.S. Treasury securities) were largely range-bound during the week.
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The U.S. economy added just 126,000 jobs in March, well below forecasts, including our own. Of greater concern was that January and February payrolls were revised down by a combined 69,000, slowing the average monthly job gain to 197,000 in the first three months of the year. In the 12 months prior to March, employment growth averaged 269,000 per month. Wages, always a key focus, increased 0.3% in March and 2.1% on a year-over-year basis, both close to forecasts.
Other reports released during the week pointed to a pickup in activity that should serve as a springboard for better economic performance in the second quarter. Among the releases:
European economic activity continues to be encouraging. Markit’s Eurozone Manufacturing PMI hit 52.2 in March, a 10-month high, and business confidence jumped to its highest level in almost four years. Moreover, deflationary conditions in the region are easing, and German unemployment touched a new record low of 6.4%.
Meanwhile, international creditors are evaluating Greece’s latest—and most comprehensive—reform plan to date but have yet to unlock any bailout funds. Our primary concern remains the potential for a run on Greek bank deposits that could increase the odds of Greece’s exit from the eurozone.
Although it is possible that the downdraft in U.S. jobs growth signaled an economy approaching full employment, we believe the March report reflects the vestiges of the severe winter and job cuts in the energy sector. Consequently, we anticipate a return to stronger job gains as early as next month, and the already steady improvement in wages to accelerate during the second half of the year. This will lead to a more confident consumer and more consistent, broader annual economic growth in the neighborhood of 3%. We expect the unemployment rate, which held stable at 5.5% in March, to approach 5.0% at full employment.
For the Fed, consistent wage increases buy time before making a final decision to raise interest rates. If we are indeed already at full employment and job growth slows, wage gains will accelerate more quickly, suggesting a faster rate-hike scenario.
In Europe, Germany remains the economic bright spot. German growth will benefit countries across the periphery of the region—except Greece. The eurozone is accelerating at a faster pace than we expected, and the European Central Bank’s balance sheet is expanding—a sign that quantitative easing is taking hold. Accordingly, we are increasing our forecast for annual GDP growth in the Eurozone from 0.9% to 1.5%, which is still below consensus estimates.
For U.S. stocks, our base case remains an intermediate target of 2,150 for the S&P 500, a level from which we could then see a correction of 5% to 10%. Our longer-term target remains 2,200 or above. In fixed-income markets, 10-year and 30-year Treasuries look fully valued, especially with growth in Europe now looking more positive. Overall, given current bond market yields and stock prices, we believe equities offer better relative value than fixed income. In terms of flows, we see support for corporate bonds, especially investment-grade, continuing for the remainder of the year.
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Foreign stock market returns are stated in U.S. dollars unless noted otherwise.
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