Weekly Investment Commentary- 31st Jan 2012
31 Jan 2012
A Mixed Week for Stocks
The multi-week rally in equities took a breather last week as markets produced mixed results. Thanks in large part to a strong earnings release from Apple Inc., growth areas of the market outperformed value areas. For the week, the Dow Jones Industrial Average dropped 0.5% to 12,660, the S&P 500 Index was up marginally to 1,316 and the Nasdaq Composite climbed 1.1% to 2,816.
Economic Data Continues to Skew Positively
The economic highlight of last week was the release of the preliminary fourth-quarter US gross domestic product (GDP) report, showing that GDP grew by 2.8% in the last quarter of 2011. This pace represents the fastest growth since the second quarter of 2010, but the details within the report were somewhat mixed. On the positive side, the data showed that US private consumption and private fixed investment were both up. In contrast, the data also showed that the largest positive contributor to growth came as a result of inventory accumulation, which tends to be quite cyclical. On balance, the report paints a picture of modest, if unspectacular, growth in the United States.
At the end of this week, we will see the release of January’s US employment report. Initial unemployment claims have been falling in recent weeks, suggesting that jobs data is improving and we should expect to see better employment figures in the months to come. Expectation is that jobs growth is likely to average around 150,000 per month, adding up to 1.8 million new jobs for all of 2012. That should be enough to continue to bring the unemployment rate down, but it is expected not to fall below 8.0% by the end of 2012.
Taking a step back, it does seem clear that the US economy has improved since the lull in growth in the middle of 2011 that was caused by the natural disasters in Japan, higher energy prices and the consternation over the debt ceiling debate.
US Politics and the Fed: No Changes for Now
President Obama delivered his State of the Union address last week and, not surprisingly, the majority of his comments focused on economic issues, particularly regarding the manufacturing sector and broader tax policy. In terms of infrastructure spending, the President proposed a significant spending increase by using half of the savings that will be achieved by the winding down of the wars in Iraq and Afghanistan. Regarding tax policy, the most significant change he advocated was for individuals with over $1 million in income to pay a minimum effective tax rate of 30%.
The US Federal Reserve also met last week and, in their new era of openness, announced that the central bank would maintain a highly accommodative monetary stance for
the foreseeable future. In particular, the Fed indicated that it plans to keep rates at their current near-zero level through at least late 2014, a longer timeframe than it had previously indicated. The Fed also left room for the possibility of additional quantitative easing, but as expected, nothing definitive was announced.
The Background for Stocks Remains Constructive
From a technical perspective, the market backdrop continues to be a strong one.
All of the major indices are trading at above their 200-day moving averages and the advance/decline lines are trending quite strong. Additionally, fund flows are starting to move in a positive direction for stocks with some evidence suggesting that investors are starting to get back into the markets (although the amount of cash on the sidelines remains extremely high).
Although economic and market data is looking better than it did several months ago,
it is important to remember that significant downside risks remain. The European debt crisis still has the potential to spiral out of control and investors need to keep an eye on potentially rising oil prices.
On balance, however, the positives outweigh the negatives. Central banks remain highly committed to promoting better economic growth and while we are not expecting to see a clear resolution for the European debt crisis, we do expect it to remain reasonably well contained. Given this backdrop, it is likely that modest levels of economic growth should continue, which should help pave the way for risk asset out-performance.
Even though some of the more recent data in the US have been reasonably good, investors are focusing on another looming recession in Europe and downside risks to growth elsewhere. While a resurgence in commodity prices could add to upside inflation risks, it’s otherwise likely that inflation pressures should remain reasonably modest. No major countries are seeking currency strength and this is a key indicator that policymakers are not concerned about inflation.
Bonds
Italian bonds rose, with two-year yields sliding to their lowest since September, after the country sold €5 billion worth of bonds at lower yields than previously. Spanish bonds also gained for similar reasons. However, German bonds gained as Greece and its creditors struggled to reach agreement over a debt-swap. The Merrill Lynch over 5 year government bond index ended the week 1.6% higher.
Currencies
In currency markets, the euro strengthened against the dollar, gaining steadily following the Fed comments regarding interest rates. The €/$ rate finished the week at almost 1.32, a gain of 2%.
Oil
Oil prices rose for another week, this time mainly on the back of good economic data in the US. Oil finished the week just shy of $100 a barrel.
About
Neal Kelly is a Co-Founder and a Director of Thomond Asset Management and can be contacted @ neal@thomondam.com
