Weekly Markets Commentary — April 3, 2016
David Joy – Chief Market Strategist, Ameriprise Financial
A strong first quarter ends on an uncertain note
It was a good first quarter for global equities. The MSCI World index climbed 5.9 percent in dollar terms, its best quarterly gain since the fourth quarter of 2013. In the U.S., the NASDAQ Composite index climbed 9.8 percent, the S&P 500 index rose 5.5 percent, and the Russell 2000 index managed to deliver 2.1 percent. But the optimism that drove most of these returns in the first two months of the year faded in the final month of the quarter. The NASDAQ still rose in March, but added just 1.5 percent of its quarterly total, while both the S&P 500 and the Russell 2000 fell fractionally.
Stocks were due for a pause after the powerful surge following the election in November. But beyond simply needing time to digest those gains, the rally stalled as investors took stock of the political landscape and began to temper their enthusiasm for sweeping policy change. Importantly, however, stocks did not give back very much of their post-election gains as the quarter came to a close. In fact, the S&P 500 ended the quarter just 1.5 percent below its March 1 record high of 2396.
As the new quarter gets underway, in addition to policy, investor concerns are lately centered on questions concerning the relative strength of the economy, and the usual jitters about the upcoming first quarter earnings season. A lot of handwringing has followed evidence that while so-called soft economic data has been strong recently, that same strength has not shown up in the so-called hard data. In our view, such concerns are overdone. But if the potential boost from policy turns out to be smaller and possibly delivered later than hoped, and the underlying economy is softer than forecast, the pressure on earnings to deliver has increased, especially with equity valuations on the high side. Factset estimates earnings will grow 9.1 percent in the first quarter, after a smaller-than-usual estimate decline from the start of the year.1
Just as stocks in the U.S. were beginning to stall in March, stocks in the Eurozone began to surge. The EuroStoxx 50 index rallied by 5.5 percent in March after a modest gain in February and a small decline in January, closing out the period 6.4 percent higher, and higher by 7.9 percent in dollar terms. It was the opposite monthly pattern exhibited by U.S. stocks throughout the quarter. As political uncertainty increased at home, it began to recede somewhat in the Eurozone following relatively poor showings by populist candidates in Dutch national elections and in German regional elections. Economic optimism also rose, just as it began to fade at home. And just as the Federal Reserve was raising interest rates in March for the second time in three months, the European Central bank was reiterating its commitment to accommodation.
Stocks in Japan fell 1.1 percent in the quarter after failing to gain any traction throughout. Dollar weakness played a big role, as it began the year at 117 yen and closed it at 111. As a result, in dollar terms the Nikkei index actually gained 3.7 percent.
The star performers for dollar-based investors in the quarter were the emerging markets. The MSCI Emerging Markets index delivered a solid 7.5 percent gain in local currencies, which translated into an 11.1 percent gain in dollars, as worries over dollar strength and possible trade wars dissipated, with particular strength in Asia.
Positive returns on bonds
It may come as something of a surprise, but bonds also delivered positive returns in the quarter. Although, like stocks, bond yields peaked in March, they have been trading in a fairly tight range since mid-December. Since then, the yield on the ten-year note has ranged between 2.30-2.60 percent. For the quarter, the Bloomberg Barclays Aggregate Bond index rose 0.8 percent, a sharp turnaround from the fourth quarter when the yield on the ten-year note rose from 1.59 to 2.44 percent. Lower quality bonds outperformed in both the investment and below-investment grade space, but like stocks, faded in March as credit spreads widened. The Bloomberg Barclays un-hedged Global Aggregate index rose 1.8 percent in the quarter.
A look ahead
As the second quarter gets underway, Congress must immediately focus on legislation to fund the federal government beyond the April 28 expiration of the current continuing resolution. These negotiations are expected to be difficult, as well as divert attention from tax reform and other policy priorities of the administration. The Federal Reserve meets twice in the second quarter, in May and June. According to Bloomberg, expectations for another rate hike in May are just 13 percent. But in June, the next meeting also accompanied by a press conference, the odds are 57 percent. By the next such meeting in September, the odds are 80 percent.2 Overseas, the French elections are fast approaching. The first round will take place on April 23, with the final on May 7. And now that Article 50 has been invoked, Brexit negotiations will get underway. And while they will stretch over as much as a two-year period, the details of both the terms of exit and the ongoing relationship with the EU will become increasingly clear.