As the first quarter came to a close, economic data turned slightly negative, as represented by the Citigroup Economic Surprise Index.  The index trended up throughout February, but then turned negative over the course of March as economic data began to surprise to the downside.  The ISM Manufacturing and Non-Manufacturing indices contributed to this decline, as both softened in March.  However, despite the moderation, both remained solidly in expansion territory.

  •  Labor markets grew 236,000 in February following a 119,000 gain in January.
    • The unemployment rate dropped from 7.9% to 7.7%.
    • February marked the best month of construction-related job growth since March 2007, supporting the notion that housing is finally breaking out of its longstanding downtrend.
  • Personal income grew 1.1% in February, well above the expected 0.9% rate.
    • Consumer spending also surpassed expectations, expanding by 0.7% in the month.
    • Income rebounded from a sharp period of volatility in December-January.  In December, incomes spiked due to employers accelerating dividends and bonuses ahead of an anticipated tax rate change in 2013.  This pulled forward much of the seasonal activity in January, causing a deep month-over-month plunge in incomes.
    • February’s 1.1% increase may indicate a normalization of the data.
  • Housing data came in mixed.  Demand for housing tapered off throughout the quarter.  However, housing starts increased after dropping off from a sharp spike in December.
    • Housing prices continued to see modest gains throughout the quarter as measured by the Case-Shiller Home Price Index.  This is positive for the housing market as the 20-city index is up over 9% since March 2012.
    • Existing home sales also improved by 0.8% in February to a rate of 4.98 million sales.  This was 10.2% over year-ago levels, and the highest since February 2009, a period boosted by the government’s tax credit stimulus.
  • The easing campaign of the US Federal Reserve Bank continued in March.
    • The FOMC remained committed to its previous policy stance following its meeting in March.  This included $85 billion in asset purchases per month, the reinvestment principle from maturing securities, and maintaining rates near zero as long as unemployment stays above 6.5% and inflation does not exceed 2.5%.
    • Many Fed officials have indicated that the Fed is in no hurry to reduce its record bond buying with inflation less than 2.0%.


A clear trend has emerged to start off 2013, namely the relative strength of developed markets compared to those of the developing world.  Markets in the US have rallied thanks to renewed optimism and improved economic results, and the Japanese market continues to ride the wave of monetary easing and currency depreciation.  Emerging Markets however are facing significant headwinds for a number of reasons.  One of the most obvious is the ongoing “currency war”, not only for economies in East Asia in the face of a depreciating yen, but also in Latin American where policy makers are establishing curbs against appreciation of their currencies if not outright competitively devaluating.  These actions are in many ways a zero-sum game, and the impacts are felt globally as economics are more interconnected.  Another reason for emerging market weakness is due to the general weakness in commodities, particularly industrial and precious metals.  A third major contributor to the weakness in the developing world is the overall capital shift to the advanced economies.  As the rally in emerging markets has been largely fueled by excess liquidity, it appears that much of the liquidity is finding its way back home in search of better returns as sentiment improves, while macroeconomic conditions in many of the larger emerging market countries have been worsening.  Whatever the reason, it is clear that investment tides have shifted in favor of the larger industrialized economies.

United States:

  • During the quarter, US equities continued the rally that began in November 2012 and outperformed most global peers as investors flocked to the relative stability and improving momentum offered by the US economy.
    • All major US equity indices rallied to new all-time highs, except for the NASDAQ, which underperformed its domestic peers to hit its highest level since March 2000 tech-bubble highs.
    • While the Dow Industrial Average enjoyed its best Q1 since 1998, the most impressive performer was the Dow Transportation Average, which rallied 19% for its strongest single quarter since Q2 of 2009.
    • The rally coincided with a sharp drop in volatility, with the VIX falling 29.5% in the quarter to its lowest levels since February 2007.
    • The market rally in Q1 was fairly broad-based, with leadership varying across different asset classes.
      • When looking at market capitalization the rally appeared to be driven by growth-sensitive areas, with microcap and small cap indices outperforming large cap.
      • Style leadership varied within asset classes, with growth leading in small caps and value outperforming in large caps.
      • Despite mixed signals, in general the rally was driven by increasing investor risk-tolerance, evident through rising valuations and consistent EPS growth (7.3%) across all asset classes.  This is evident through strong equity fund flows in Q1, which can mainly be attributed to the continued monetary support from the Fed and improving clarity on fiscal and regulatory policy from Washington following the resolution of sequestration and the fiscal cliff.
  • Despite an increasing appetite for domestic equities, investors continued to show a strong preference for defensive characteristics and high dividend yields.
    • The top three performing sectors in the Russell 1000 during Q1 were health care, consumer staples, and utilities.
      • Health care was the best performing sector in the quarter, rallying 15.8% on continued benefits from demographic tailwinds in US.
      • Consumer staples rose 14.7% in Q1, benefitting from the announced acquisition of Heinz (+25.3%), as well as the strong rebounds of recent laggards like Safeway (+45.7%), Campbell Soup (+30.0%), and Archer Daniels Midland (+23.2%).
      • The 13.6% rally in utilities was mainly driven by continuing demand for yield in a low interest rate environment.


  •   The Cyrus bailout dominated headlines in March, as markets across Europe reacted to an unprecedented plan to hold depositors responsible for saving the small nation’s banking sector.
    • Fears of bank runs in the peripheral economies unsurprising spooked markets, as Spain (-5.9% March, -5.4% Q1) and Italy (-5.2% March, -9.8% Q1) led the declines in Europe for the month.
    • The Eurozone hit an unfortunate milestone as unemployment reached 12%, the highest level in the history of the common currency
    • In the UK, falling industrial production and manufacturing have further stoked fears of a triple-dip recession.
  • Japan (+5.0% March, +11.7% Q1) led the major market indices in March, boosted by improving sentiment and domestic demand, in addition to continued aggressive policy actions.
    • The market has become extremely sensitive to central bank news; on March 22nd the Nikkei dropped 2.3% when Bank of Japan Governor Kuroda gave an announcement  which did not explicitly state a concrete plan for additional stimulus, even though it is widely understood that that will be the ongoing order.
  • China (-4.6% March, -4.5% Q1) has lagged for a number of reasons, chief among them being the curbing of investment in the property market.
  • South Korean (-4.3% March, -3.2% Q1) returned to weakness after a strong February, as exports fell 8.6% YoY.  Officials are considering introducing taxes on financial transactions to help curb excessive capital inflows and stabilize the currency in the face of the strong won vs. the yen.
  • India (0.1% March, -2.6% Q1) continues to lag due to poor economic conditions, particularly a higher than expected February inflation number.
  • Russia (-3.5% March, -3.7% Q1) suffered a significant hit from the Cyprus news, as the island’s banks serve as an offshore tax haven for Russian depositors.
  • Mexico (+3.7% March, +6.1% Q1) remains the lone bright spot in the larger emerging markets.  The market has attracted a lot of attention thanks to President Pena Nieto taking actions to establish his credibility as a reformer, including introducing competition to the telecom and broadcast industries, and potentially opening up the oil and gas sector.

Fixed Income

With rates showing life from historically depressed levels, investors are increasingly anxious about the potential damage of further increases or even a “rate shock” (a swift and dramatic increase in rates).  The theme de jour is a “Great Rotation”, or mass reallocation away from bonds and into other risks, be it equities or credit.  The strong sentiment against taking on interest rate risk is manifesting all across fixed income.

  • Long duration corporate bonds severely underperformed their intermediate counterparts even as spreads were constant; retail flows are pivoting away.
  • Emerging market investors are allocating away from hard currency bonds, which are US interest rate sensitive.  Flows have favored local currency paper, with exposure to more normalized local rates.
  • TIPS lost 0.4% during the quarter to post returns that were largely in line with US Treasuries which lost 0.2%.  Both were hurt by an increase in real rates and the slight performance differential is primarily accounted for by the longer duration of the TIPS Index.
  • Agency MBS was flat in Q1 2013.  Within agency MBS, there was a notable performance differential across the coupon stack.  Low coupon MBS were substantial underperformers as investors begin to anticipate the end of the Fed sponsorship, and due to extension concerns.    High coupon agency MBS and non agency both posted solid performance.
  • Investment grade corporate bonds lost 0.1% during the quarter falling in line with Treasuries.  Income for the quarter was offset by rising yields as spreads did not contract when US rates increased.
  • High yield bonds gained 2.4% during the quarter.  Performance remained strong with investor demand for excess yield.
  • Leveraged loans rose 2.2% in Q1 2013.  Average price in the space stands at $98 – BB/B loans are already pricing at slight premiums which are their theoretical maximums.  The sector is on a 40 week inflow streak with $14B allocated YTD.  In contrast, bonds have seen $1B.
  • Intermediate municpals, as represented by the BC 1-10 Year Blend Index, gained 0.5% for the quarter as AAA municipal yield curve twisted with a pivot on the 5 year rate.  Lower credit quality still outperformed with high yield munis the performance leader.
    • Flows into munis are traditionally weak during Q1, especially in March as investors exit positions to meet tax obligations.  The first quarter is shaping up to the norm as retail flows were flat to slightly negative.
  • Emerging market bond performance was week in Q1 2013 losing 0.1% as global markets deviated from established trends.  The US dollar strengthened as investors rotated towards US capital markets.


Hedge Funds:
Hedge Funds performed reasonably well in the first quarter, although they failed to keep pace with the rapid move in the equity markets.  Not surprisingly, directional strategies performed best, as the equity sensitivity led to more robust returns.

  • Equity strategies had mixed results in the quarter.  While market neutral funds saw headwinds from a general low quality rally in the quarter, long-biased managers generated better results.  Falling cross-correlations among equities and rising single stock dispersion is providing to be a tailwind for fundamental strategies.
  • Event driven managers performed strongly in the first quarter, leading all other hedge fund categories.  Activist and special situation managers continue to lead the way, while distressed and merger arbitrage is lagging.

Other Areas:

  • Fundamentally, there was little change in the oil markets as sideways trading continued for what is now more than two years.  Rising supply from the US, Angola and Nigeria offset falling output from several OPEC members and increased demand from Asia.
  • Gold (-5.0%) was among the weakest performers primarily due to investor outflows.  More than 150 tonnes (nearly $8 million USD) worth of gold was sold in Q1, the largest such outflow in recent history.
  • MLPs enjoyed its strongest quarter ever, rising nearly 20% in the wake of a relatively weak 2012.  In part, this was catch-up from last year, but the scale of the rebound surprised many market participants.  The rise was indiscriminate, lifting up-, mid-, and downstream MLPs between 15% and 25%.  Distribution growth is expected to be in the mid single digits in 2013.


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.