Economy

The pace of positive economic data improved in February.  A stunning personal income report along with improved ISM manufacturing figures and a steep drop in the trade deficit gave the economy a lift.

  • Personal incomes jumped considerably in December, rising 2.6%. This was the biggest gain in eight years.
    • The increase was attributable to accelerated bonuses and special dividends, as companies sought to distribute capital ahead of potential tax hikes in 2013.
    • Spending was also positive, although slightly below expectations with a 0.2% increase. Negative spending growth for nondurables, specifically gasoline, weighed down the headline level.
  • On the manufacturing front, the Institute of Supply Management (ISM) reported in February that its manufacturing index accelerated to 53.1 in January. This was a jump of nearly three points, and ended a string of reports that hovered around the 50-line (which demarcates expansion/contraction in the sector).
    • New orders improved by 3.6 points, returning to expansionary territory and boosting the headline index.
    • Later in the month the composite index continued its recent strength, increasing to 54.2. Most of the gain came from the new orders and production side, which generally bodes well for future readings.
  • Housing data remained fairly positive in February, particularly housing prices.
    • The Case-Shiller Home Price Index was up 0.9% in December; in the past year, the 20-city index is up nearly 7%. Housing starts softened slightly during the month following robust January figures, but remain nearly 24% higher on a year-over-year basis.
    • Meanwhile, both existing and new home sales improved. New home sales, in particular, surged 15.6% in the month.
    • The housing market is generally being supported by some of the lowest inventory levels in years and record low mortgage rates.
  • In late January, the first estimate of fourth quarter 2012 GDP suggested the US economy contracted by 0.1%. In late February, that number was revised up to 0.1%; while an improvement, economists were disappointed by the meager pace of growth to end last year. Weakness in inventories and government spending was generally offset by consumer spending and business investment.
  • The FOMC did not meet in February, however minutes from the January FOMC meeting were released indicating committee members’ increased concerns about the impact of ongoing asset purchases surprised market participants.
    • Specifically, “several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability.”
    • The committee members’ concerns have sparked fears that the Fed could end its easing program earlier than expected. It remains uncertain whether investors see enough organic strength in the economy and in the corporate sector to stay committed to risk assets if this measure of support is withdrawn.

Equities

Global equities were mixed following January advances due to a number of macroeconomic factors. The All Cap World Index was flat for the month of February reflecting a balance between relative strength in developed Asia and the US, and weakness in emerging markets and Europe.

  • February proved to be another strong month for US equity markets, as stable corporate fundamentals, improving economic data, high levels of corporate M&A activity, and strong fund flows drove the US markets to new recovery highs, the Dow Jones Industrial Average, S&P 500, and NASDAQ higher by 1.4%, 1.1%, and 0.6%, respectively.
    • February experienced more volatility than prior months, with the VIX rising 8.8% to 15.5 on fears about the outcome of the Italian election and concerns that the Federal Reserve may scale down monetary stimulus sooner than expected.
    • Increased investor caution was evident through sector leadership, with three of the top four performing sectors in the month being defensively-oriented.
  • The Japanese market (+2.7%) continued to benefit from export growth due to the depreciating yen. The currency has now dropped 17% vs. the US dollar since the beginning of November, prompting concern from some members of the G7 of a potential currency war.
  •  News from Europe was broadly negative for the month, and this was reflected in market performance. Q4 GDP for the Eurozone contracted 0.6%, the worst quarterly decline since Q1 2009. The economies of Germany, France, and Italy all shrank more than expected. The forward-looking expectations are not much better, with the ECB predicting zero growth for 2013.
    • Moody’s downgraded the UK’s credit rating, driving the pound to a two-year low against the dollar.  The Bank of England is predicting a higher inflation outlook due to the weak pound and higher energy costs.
    • The biggest story out of Europe was the Italian elections, which had a profoundly negative impact both across the continent and globally. The Italian market (-12.6%) was the worst performer among the major economies during the month.
  • The emerging markets index continued to show weakness (-1.2%), erasing minimal January gains. The fear that the Fed will bring an earlier end to stimulus measures affected investor sentiment as the rally in emerging markets has largely been fueled by excess liquidity.

Fixed Income

Bernanke boosted credit markets during his semiannual address to Congress. The chairman took a dovish tone by highlighting the benefits of the Fed’s unconventional purchase programs and downplaying potential costs. In particular, Bernanke assuaged market fears about the early termination of its QE programs. High quality fixed income, as represented by the BC Aggregate Index, returned 0.5% in February.

  • Investment grade corporate bonds gained 0.8% during the month as price movements are primarily driven by Treasury rates thus far in 2013.
  • Intermediate municipals, gained 0.3% during the month. Muni yields generally lag Treasury moves so the market underperformed on a relative basis.  Investors may be rotating into higher quality intermediate products to position more conservatively in terms of credit and duration.
  • Leveraged loans gained 0.2% in February. Retail flows into loans continue to accelerate to historically strong proportions. The month saw weekly inflows of $1.4B, $1.3B, and $1.2B, which represent the top three heaviest flows ever for the sector. However, loan yields are poised to scale down with record re-pricing activity.
  • US TIPS underperformed nominal Treasuries with a 0.0% return. Lower inflation expectations cancelled out gains from decreases in the real yield. Higher gasoline prices, which were pressuring inflation prints at the start of the year, eased in February.
  • Agency MBS gained 0.3% during the month. Total returns for the sector continues face the headwind of mortgage pre-payments.

Alternatives

In an environment rewarding fundamentals, hedge funds and alternative investments are returning to more favorable status. Directional strategies did well in the month with modest market exposures.  Systematic trading (Managed Futures) strategies continue to be the laggard, posting a modest loss in the month due to a handful of trend reversals.

  • Equity Hedge and Market Directional Indices posted gains of 1.2% and 0.6% in the month. Current consensus that equities are one of the more attractive asset classes can be seen in managers willingness to increase equity exposures. According to prime brokerage reports, net market exposure in the equity hedge universe has risen quickly since the start of the year.
  • Event driven managers also posted positive returns in February to continue the more favorable backdrop for that strategy.  The index was up 0.5% in February and 3.8% YTD. Activist and special situations managers are leading the way, while distressed and merger arbitrage lag.  This year has been notable for the event driven space as many of the recent deal announcements are the largest seen since the financial crisis.  It appears we are still in the early phases of the cycle based on corporate leverage ratios, cash on balance sheets and overall activity levels.
  • Yield-heavy liquid real assets generated range bound returns in February.  Commodities were the relative laggard, led lower by sequestration concerns in the US, Italian Parliamentary elections, and less than stellar import and PMI data out of China.
  • Gold fell 5.0% in February owing to investor skittishness.  According to Barclays, gold investments closed the month at their lowest level since 2008 and new shorts at the highest level since 1999. Flow data shows that February was one of the worst months on record, with GLD suffering nearly $4 billion in outflows.  New access points to gold have allowed investor interest to grow and even outpace jewelry demand.  This has resulted in a fickle pricing environment prone to bouts of volatility.
  • Energy prices were unsupportive of commodity exposed MLPs in February. An uptick in natural gas futures ate at the margins of gatherer and processor operators, while falling oil prices hurt upstream operators. Neither of the above had a material impact on midstream operators. MLPs finished the month yielding 6.0%, although at certain points the number fell into the fives. The last time that happened was a year ago when the US 10-year was also yielding near 2.0%. The historical spread between the two is close to 300 bps.

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.