Economy

As April came to a close, economic data reversed its negative trend throughout the month, as represented by the Citigroup Economic Surprise Index.  The index continued to show signs of weakening in April, but then turned positive going into May as economic data began to surprise on the upside.

The ISM Manufacturing and Non-Manufacturing Indices continued their trends down in April.  The ISM Manufacturing Index moved lower from 51.3 in March to 50.7 in April while the ISM Non-Manufacturing Index followed, declining 54.4 to 53.1.  Both still remain in expansionary territory, but continue on a steady downward trend.  This period of the year has been difficult over the course of the past several years and it looks like this year is not going to be an exception.

  • Labor markets continue to show signs of improvement with employers adding 165,000 workers to nonfarm payrolls in April.
    • The unemployment rate continues to decline steadily, dropping from 7.6% in March to 7.5% in April.
    • Professional and business services led the way adding 73,000 jobs followed by leisure and hospitality with 38,000 jobs added.
    • The bright spot in the jobs report came from prior month revisions.
      • March was ratcheted up from 88,000 to 138,000 while February was revised to 332,000 from 268,000.
  • After a quick rebound in February to 1.1%, personal incomes fell sharply in the month of March to 0.2%.
    • This negatively impacted consumer spending during the month.  After four months of steady growth, consumer spending dropped from 0.7% in February to 0.2% in March.
    • Personal incomes and consumer spending may still be finding their normalized levels as the December print was boosted by accelerated dividends and bonuses ahead of the anticipated tax rate change going into 2013.
  • Housing data once again come in mixed.  Demand for housing experienced a decline from 44 in March to 42 in April as measured by the Housing Market Index (HMI).  The index continues to tread down throughout 2013.
    • Housing starts, however, continue to increase throughout the year, jumping from 968,000 in February to 1,036,000 in March.
    • Housing prices continue to see modest gains.  The S&P/Case-Shiller Home Price Index continues to trend up.
  • Central banks around the world continue to provide increased stimulus to their respective economies.
    • Following the FOMC meeting that occurred on April 30-May1, the US Federal Reserve Bank announced that it will maintain its goal of buying long-term Treasury bonds and housing-related debt worth $85 billion along with targeting a federal funds rate of 0-0.25%.  Monetary policy remains unchanged from their last meeting in March, stating that it may alter the amount of bonds it will be purchasing, contingent on the state of the US jobs market and inflation.
    • The European Central Bank (ECB) announced on May 2nd that it will cut its main policy rate by 25 bps.  This brings the rate to 0.5% as they continue to provide banks with all the money they need “for as long as necessary.”
    • The yen continues to remain weak relative to the US dollar as the Bank of Japan (BoJ) announced formal plans of aggressive monetary easing on April 4th.  Following the April 4th meeting, the yen weakened roughly 7% relative to the US dollar in the matter of days, but has since come down slightly.

Equities

A few weeks ago, Art Cashin of UBS coined the current market advance as the “TINA Rally,” (There Is No Alternative), as aggressive monetary policies globally are pushing investors into equities to achieve acceptable levels of returns in their investment portfolios.  The performance of global equity markets in April certainly appears to confirm this hypothesis, with both Japan and Europe leading the march higher after the BOJ and ECB each reaffirmed their commitment to support their respective economies with quantitative easing.  Although the US markets lagged their global peers, the positive impacts of Fed policy have been clearly visible in the 1.8% advance despite earnings results that have been plagued by disappointing revenue growth and forward guidance.  Emerging markets continued to lag in April as these countries struggle with slowing economic growth, deflationary commodity prices, and stronger currencies relative to their developed counterparts.  While expanding valuation multiples is a positive reflection of improving investor sentiment, with developed markets trading at elevated levels, it will be increasingly important to see these higher valuations confirmed through improvements in company fundamentals and global economic data.

United States:

  • Despite lagging most international benchmarks, US markets continued to rise in April, shrugging off disappointing economic data and lackluster earnings results.
    • Dispersion among the major markets was lower than in previous months with the S&P 500, NASDAQ Composite, and Dow Jones Industrials Average rising 1.8%, 1.9%, and 1.8% respectively.
    • A troubling divergence emerged between industrial and transportation stocks, with the Dow Transportation Average falling 1.2% in April and lagging the Industrial Average by 303 bps, the widest margin since last September.
    • Implied volatility increased modestly, with the VIX rising 6.5% in April to 13.5.  However, overall the VIX remains range-bound at multi-year lows, indicating low levels of fear despite the markets trading at elevated levels.
    • April’s advance was led mainly by large cap equities, with the Russell 1000 Index outperforming the Russell 2000 by a margin of 250 bps.
      • Style leadership varied for market caps, with growth outperforming in large and value outperforming in small.
        • Both divergences can be largely attributed to the relative outperformance of developed international markets in April, which contributes a larger share of earnings to large cap growth stocks.
        • Conversely, small cap stocks have more exposure to growth in the domestic economy, where data was mostly disappointing during the month.
        • The US dollar, which fell 1.5% in April, also supported the outperformance of large cap growth equities, with a weaker local currency boosting the value of earnings earned overseas.

 International:

  • Peripheral Europe, led by Italy (+12.0%) and Spain (+10.5%), appeared to enjoy a relief rally in April, in what can be deemed a “no news is good news” type of environment.
    • Fundamentals remain weak across the continent, as the Eurozone turned in its fifth straight quarter of contraction, and German PPI dropped below 50.
    • The ECB left rates on hold during the month, but announced a cut to 0.5% on May 2nd.
    • The UK surprised with 0.3% Q1 GDP growth despite continued contractionary fiscal policy.
  • The big news out of Japan (+8.8%) was the BOJ’s announcement that it would be doubling-down on asset purchases which, while not surprising based on recent experience, is still unprecedented from an economy of that size.
  • The economy in China (+1.1%) continues to slow.  The country turned in a lower than expected 7.7% Q1 GDP growth number driven by weak consumption, and also suffered a local currency credit downgrade by Fitch.  Export growth pulled back as global demand has slowed.

Fixed Income

First quarter fears of immanent rising interest rates melted away with a disappointing domestic jobs report and weak growth numbers from around the world, especially China.  Treasury yields fell across the curve in a bull flattening which was supportive of gains for most US fixed income markets during the month of April.

  • The yield on the ten year, which had threatened to break above 2.0% in the first quarter, ended the month at 1.7%.
  • The BC Aggregate Index gained 1.0% in April with returns predominantly driven by falling Treasury yields.
  • TIPS gained 0.8% during April slightly lagging the performance of duration equivalent Treasuries.  Absolute performance was driven by falling real yields.  TIPS yields did not fall as much as their nominal counterparts, however, as inflation expectations declined.
  • Agency MBS gained 0.5% with positive price returns partially offset by stubbornly high prepayments.  In a reversal from Q1 2013, lower coupon securities significantly outperformed their higher coupon peers.  These securities, which are targeted by the Fed in their purchasing programs, are becoming very sensitive to macroeconomic indicators.  A weaker outlook in April gave confidence to investors that the Fed was less likely to curtail QE in 2013.
  • Investment grade bonds gained 1.5% during the month.  Spreads were static and gains were due to falling Treasury rates.  Thus far in 2013, returns for the sector have been driven by Treasury moves.  Spreads did not compress during the robust markets of Q1 2013 nor did they rise as Treasury yields fell back in April.
  • Intermediate Municipals, as represented by the BC 1-10 Year Blend Index, gained 0.7%.  Yields feel across the curve in similar fashion to the US Treasuries resulting in some performance benefit to holding long maturity munis.  The muni credit story was more mixed in April with high yield munis giving up their long held performance leadership. Within investment grade munis, the performance differential amongst credit tiers was relatively narrow and no clear quality hierarchy was established.
    • Municipal mutual fund flows ended the month on a seven week long losing streak.  Long term and high yield funds are exhibiting the most weakness while intermediate strategies were relatively insulated.  Valuations for munis have held steady despite the outflows.
  • With the notable exception of the Japanese yen, the dollar was broadly weaker against both major developed and EM currencies.  EM bonds benefitted from falling yields in developed countries with the EU and Japan becoming increasingly accommodative.

Alternatives

Hedge Funds:
Alternative investments generated modest returns in April, in what was a mixed month for equity markets.  The overall dispersion of strategy performance was fairly compressed, as both directional and more hedged strategies posted positive results.  The lone category that lost money during the period was systematic diversified strategies, although the HFRX index appears to be out of synch with the performance of most big players in the space.

  • Equity strategies had mediocre performance in April.  Despite increasing bullishness among hedge equity managers, collectively those Funds were only able to capture a third of the S&P 500’s monthly performance.
  • Event driven managers continued to perform well in April, led by distressed Funds as well as unhedged activist products.  Merger arbitrage managers generated respectable returns during the month amid an apparent uptick in activity.

Liquid Alternatives:

  • Managed futures were the best performing category in April, reversing several quarters of disappointing performance.  Managed futures mutual funds outperformed comparable hedge funds largely due to the higher allocation towards traditional trend based models.  There was a wide dispersion among managers, but relatively few posted negative performance.  Positioning tended to favor a long equity posture, along with long US Dollar and long government bond.
  • Long/short equity mutual funds performed nearly identical to their hedge fund peers, gaining 0.5%.  Performance was mixed across the board due to divergent performance at the sector level, as mentioned previously.

 Liquid Real Assets:

  • Crude oil fell on global economic growth concerns.  The International Energy Agency cut its 2013 global oil demand forecast for a third consecutive month in April to 795,000 barrels per day (5% lower than the previous figure).  Natural gas (+6.9%) was again a bright spot, aided by cooler weather and falling rig counts.
  • Mid-month, gold experienced a two-day sell-off not seen in more than 30 years, spurring a wave of precious metals declines.  On Friday, April 12 and the following Monday, more than 1 million gold futures contracts (equivalent to more than 1 year of global mine production) were traded on the COMEX.  The metal fell below $1,500/oz and subsequently burnt through several technical support levels to fall below $1,350/oz on April 15.  The action in futures trading was unique since normally 90% of gold volume comes via the spot market.  Hence, several reports surfaced blaming “orchestrated” naked short selling for the decline.  The metal rebounded above $1,450/oz at month–end, but remained below the $1,561 April 11th close.
  • A record Q1 for MLPs was followed by a flat April, as the earnings and distributions announcement season began to wind down.  As a reminder, MLPs tend to catch a tailwind during distribution season (January, April, July, and October) because most distributions are 80-90% return of capital, and therefore tax-deferred.

Disclosures

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.