Financial Markets Review and Outlook:
Fourth Quarter 2012
Managers Investment Group
January 9, 2013
Market and Economic Review
As expected the fourth quarter economic landscape was
dominated by the U.S. Presidential and Congressional
elections and their collective impact on the fiscal cliff. After
the elections were completed, markets nervously awaited the outcome of the fiscal cliff negotiations as economists generally
predicted dire consequences for the U.S. economy in 2013
if a timely resolution was not reached by the end of the year.
Despite a resolution on the tax aspects of the fiscal cliff not
being reached until just beyond the final hours, equities and
other risk-based assets generally delivered flat performance
overall for the quarter after difficult performance leading up to
the elections. Meanwhile, Hurricane Sandy exerted not only a
tragic human toll, but threatened to serve as another headwind
for economic growth, at least in the short-term, here in the
U.S. After a busy third quarter, which featured the launching
of “QE3,” the Federal Reserve (the Fed) remained largely
out of the business news cycle in the fourth quarter as their
bond-buying programs continued in earnest. That being said,
a more divided Fed appeared to rear its head toward the end
of the year with officials split on how long to continue their
bond-buying programs amid no significant improvement in the
U.S. job market.
During the third quarter, U.S. gross domestic product (GDP)
grew 3.1% on an annualized basis up sharply from the
disappointing GDP growth posted during the second quarter.
Meanwhile, the ISM Manufacturing PMI Index, which serves as a measure of manufacturing growth, rose in December
after a disappointing mid-quarter reading. A reading of 50
generally signifies growth and a reading below 50 is a sign of
contraction, with the Index at 50.7% by the end of the quarter.
There was more mixed news on the jobs front in the fourth
quarter, with the U.S. economy ending the year by adding
155,000 jobs in December, albeit with the unemployment
rate remaining unchanged at 7.8%. This was broadly in line
with economists’ expectations and the last jobs-related data of
the year represented an improvement over November after a
somewhat anomalous reading related to the temporary impact
of Hurricane Sandy. Economists generally see little hope for
short-term optimism with regard to hiring or additional job
creation as ongoing business uncertainty related to unresolved fiscal cliff issues should keep employers on the hiring sidelines
for the immediate future.
Meanwhile, the housing market continued to build on its
positive momentum. Various metrics, including both new
home construction data as well as sales in existing home
sales, showed signs of improvement. New construction fell slightly from October to November but was still 21% higher
than a year prior and may have been temporarily impacted by
Hurricane Sandy in much of the Northeast portion of the U.S.
Nevertheless, the combination of ongoing record low mortgage
rates, increasing use of government programs to allow more potential homebuyers access to these rates, falling foreclosures
and a somewhat improving economy have served as a backdrop
for the recent turnaround in housing, which could play a
significant role in 2013 GDP growth and beyond.
Despite the ongoing uncertainty around the fiscal cliff, market volatility, as measured by the Chicago Board Options Exchange’s Volatility Index (VIX), remained surprisingly low for the majority of the quarter while investors remained cautiously optimistic. The VIX only spiked briefly toward the end of the quarter when political posturing appeared as though it would inhibit any deal from being completed by the fiscal cliff deadline. At the stock level, Apple Inc. was the dominant name in the news, as its’ shares fell by 20% after release of the iPhone 5, only a quarter after becoming the largest U.S. company from a market-capitalization perspective. Apple stock had been up nearly 70% from the beginning of the year and tax selling by investors played a part in its decline.
Outside the U.S., equities rallied in Europe again as markets
took comfort in efforts earlier this year to save the Euro and
to keep the sovereign debt crisis issues impacting Greece and
Spain from spreading across the continent. Nevertheless, many
still see recent market strength in Europe as nothing more than
a “relief rally” and continue to view Europe as an area fraught
with structural issues that will take years to overcome, with
many competing forces that could lead to further geopolitical
instability similar to what we saw in 2012. In China, a sharp
rally in December closed the year on a positive note, albeit well behind the equity markets of the majority of the rest of the
world, as skepticism remains about Chinese officials’ ongoing
ability to effectively manage a slowing economy.
Bonds
Much like equities, fixed income markets within the U.S.
collectively saw modest gains during the fourth quarter, as
measured by the Barclays U.S. Aggregate Bond Index, which
returned 0.2%. For the second straight quarter, high-yield bonds were the best performers, returning 3.2% as measured
by the BofA Merrill Lynch US High Yield Master II. Credits,
in general, performed well for the quarter while Treasuries,
particularly longer-dated issues, lagged amid an increased appetite for yield in other areas of the market. Outside the U.S.,
fixed income markets had difficult performance after a solid
third quarter, returning -1.0% as measured by the Barclays
Capital Global Aggregate x-U.S. Index in U.S. Dollar terms,
partially driven by a strengthening U.S. Dollar.
Stocks
Despite the uncertainty that overhung markets during the end
of the year, equity indices performed reasonably well. Broad
U.S. equity benchmarks had mixed results with some modestly
positive (the Russell 3000® Index returned 0.3%) and some
modestly negative (the Dow Jones Industrial Average returned
-1.7% and the S&P 500 Index returned -0.4%) for the quarter.
Small-capitalization equities returned 1.9% outperforming the
0.1% generated by their large-capitalization counterparts, as
measured by the Russell 2000® and Russell 1000® Indices,
respectively. Outside the U.S., equity markets generated
solid returns for the second straight quarter led by non-U.S.
developed markets, which returned 6.6% as measured by
the MSCI EAFE Index. Emerging markets also boasted a
solid return of 5.6% for the final three months of the year as measured by the MSCI Emerging Markets Index. From a sector
perspective in the U.S., the industrials and financials sectors
were the best performers, while holdings in the information
technology and telecommunication sectors detracted the most.
Unlike a majority of periods over the prior several years, there
was no clear leader or laggard sector(s) based upon an overall
“risk on\risk off” theme and, generally speaking, performance
within a sector was driven by fundamentals specific to that
particular sector. From a style standpoint, value outpaced
growth by nearly 3% for the quarter as measured by the
Russell 3000® Value and Russell 3000® Growth Indices
which returned 1.7% and -1.2%, respectively.
Outlook
The resolution of the tax portion of the fiscal cliff temporarily
alleviates a good part of market uncertainty as we enter the
New Year. While addressing the most important immediate
concern for the economy, Congress nevertheless simply “kicked
the can” on several important issues that, if not resolved to the
market’s liking, may serve as a significant cloud to the already
tepid growth prospects here in the U.S. More specifically,
spending cuts and yet another debt ceiling remain unresolved
and almost all pundits believe even the new Congress will struggle to overcome bipartisanship in an effective manner
and will likely walk us right up to, and possibly over, these
cliffs as well. There is certainly evidence that shows hints
of both optimism and pessimism among the U.S. populous. Even with the constant political bickering evident throughout
the fourth quarter, for a majority of the quarter consumer
sentiment remained surprisingly strong while market volatility
was somewhat benign, at least until the final days of the fourth
quarter. And, as previously noted, risk-based assets performed
reasonably well despite the market uncertainty. We mention
this in the context of setting expectations for the first portion
of 2013 with the markets yielding the potential to overcome
political uncertainty. That being said, there was evidence
that companies in particular small businesses, continued to
limit spending in the fourth quarter amid the uncertainty and
we remain concerned that this trend will continue into 2013
as nervous business owners wait for more fiscal resolutions. This threatens to dampen GDP growth and any significant
improvement in the job market, which consequently, will likely
lead the Fed to continue their bond-buying programs for the
foreseeable future.
Amid the uncertainty, however, risk-based assets continue
to look very favorably positioned. Valuations across equity
markets, on a global basis, look attractive on a historical
basis and certainly in comparison to the opportunities
available within fixed income markets. Valuations only appear
“stretched” in higher dividend-yielding securities favored by
investors who, hungry for yield have driven these valuations
to levels not seen in some time. Fixed income securities and
fixed income asset flows continued to defy the odds in 2012,
despite historically low yields and compelling opportunities
in other risk-based assets, as investors continued to seek
return of their capital as opposed to return on their capital. As
investors continue to grow weary of receiving no-to-negative real returns on these investments into 2013, and resolution
occurs on some of the aforementioned issues, we believe the
tide will, finally, start to turn in favor of more risk-based assets.
The lack of enthusiasm for risk-based assets, and equities in
particular, only serves as further support for these investments
as investor flows tend to be a contrarian indicator. Finally, after
many years of elevated correlations across investments within
various asset classes, we began to see a breakdown of these
correlations in 2012 that we expect to continue into 2013 as the
market begins to choose amongst the so-called “winners” and losers.” This bodes well for active managers, in particular,
who seek low-to-no correlation among the investments within
their asset class, as this tends to be the best environment to
show their skills and outperform passive benchmarks.
Please note that all performance data and comments are for the period from September 30, 2012 through December 31, 2012. Any sectors, industries, or securities discussed should not be perceived as investment recommendations. The views expressed represent the opinions of Managers Investment Group LLC and are not intended as a forecast or guarantee of future results. The information and opinions contained herein are current as of December 31, 2012 and are subject to change without notice. Information has been obtained from sources believed to be reliable, but its accuracy, completeness, and interpretation are not guaranteed. The S&P 500 Index is proprietary data of Standard& Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved. The Russell 1000®, Russell 2000®, and Russell 3000® Indexes are trademarks of Russell Investments. Russell® is a trademark of Russell Investments. All MSCI data is provided ‘as is’. The products described herein are not sponsored or endorsed and have not been reviewed or passed on by MSCI. In no event shall MSCI, its affiliates, or any MSCI data provider have any liability of any kind in connection with the MSCI data or the products described herein. Copying or redistributing the MSCI data is strictly prohibited. An investment cannot be made directly into an Index. Index returns do not reflect any fees, expenses or sales charges. Investment advisory services are offered by Managers Investment Group LLC. Funds are distributed by Managers Distributors, Inc., member FINRA. F011-1212
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