U.S. stock markets continue a bull run
March was another excellent month for U.S. markets, with the S&P 500 Index up 3.75 percent, the Dow Jones Industrial Average rising 3.86 percent, and the Nasdaq gaining 3.4 percent. For the quarter, the three indices climbed 10.61 percent, 11.93 percent, and 8.21 percent, respectively.
The Dow and the S&P 500 hit all-time highs in the first quarter (see chart). Technical factors have been strong, and the record highs indicate no remaining resistance levels. Fundamental factors, however, are less supportive, with earnings growth estimates declining over the quarter.
International markets performed less well, reflecting ongoing economic and political challenges outside the U.S. The MSCI EAFE Index gained 0.84 percent in March and was up 5.15 percent for the quarter. On a price return basis, the MSCI Emerging Markets Index lost 2.09 percent for the month, pulling it into the red for the quarter and leading to a 2.14-percent decline year-to-date. Technically, both indices have shown weakness.
Risk outperforms safety in fixed income markets
The Barclays Capital U.S. Corporate High Yield Index returned 1.02 percent in March, making it the best-performing U.S. fixed income sector, while bank loans also performed well. Meanwhile, municipal bonds lost ground, and longer duration bonds underperformed. The Barclays Capital Aggregate Bond Index returned 0.08 percent for the month and lost 0.13 percent for the quarter.
Treasury and mortgage yields remain at extremely low levels, thanks to monthly Treasury and mortgage purchasing by the Federal Reserve. Meanwhile, the 10-year Treasury closed the quarter yielding 1.85 percent.
Washington, DC and the dog that did not bark
Despite the fiscal cliff tax increases, consumer spending continued strong during the quarter, and the economy appeared to stay on track. Similarly, sequestration cuts seem to have had minimal effect on the economy so far, though it is too early to measure their effects, as the cuts will be implemented over time. In addition, at the beginning of the year, Congress and the White House appeared set to continue to battle, but so far they have avoided a government shutdown.
Housing and employment continue to strengthen
Housing has been a principal driver of growth, as a decline in the supply of homes for sale has led to price increases at the national level. The declining supply has also led to higher levels of new home construction, which recently reached a five-year high.
The housing recovery has engendered employment gains. In fact, according to Capital Economics, housing construction has accounted for one-fourth of the jobs created in the first quarter. That matters, particularly because many workers hired were among the long-term unemployed.
The rest of the world
Continued recession in many European economies is depressing expectations, and the uncertainty associated with the rescue of the Cypriot banking system has reinforced the perception that the European crisis is not over. Emerging markets suffered from the slowdown in Europe and from country-specific issues, including wage pressure and weak manufacturing in China, inflation in Brazil, and worries about natural gas prices in Russia. Threats from North Korea to attack other nations, though believed to be saber-rattling, should nonetheless be monitored carefully.
U.S. recovery continues but risks remain
The U.S. recovery is broad based, though risks remain. After all, in previous years, we have had strong first quarters followed by weak second quarters.
As for the financial markets, tailwinds in the form of lower interest rates and company share buybacks have driven markets to new highs but may be less supportive going forward. Though technical factors remain solid, the higher the markets go, the more the potential for a setback.
Overall, we are in a relatively good place, certainly better than other areas of the world. As such, investors have reasons for optimism, even as they should be mindful of the risks.
Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.