Economic Outlook First Quarter 2013
Investors Keep Calm and Carry On
By: James R. Solloway, CFA, Managing Director, Senior Portfolio Manager SEI
The Portfolio Strategies Group recently released its first-quarter 2013 Economic Outlook. A summary of its conclusions is provided below:
- Investors have been subjected to a bombardment of bad news over the past few months. In the U.S., federal-government budget battles have been front and center. The fun and games in Washington have been more than matched by the root-canal economics in Europe. Fiscal austerity continues to take a huge toll throughout the region, driving the eurozone’s unemployment rate to nearly 12%. The only answer the elites can find to correct the situation? More austerity! One might think that this steady stream of bad news would leave investors paralyzed with shell-shock. On the contrary, markets have shown amazing resilience.
- U.S. stocks had their best January showing since 1997. Historically, this has typically been a favorable omen for full-year equity returns. With the notable exception of the European Central Bank (ECB), central bank policies remain supportive of financial assets. We believe economic circumstances—not only struggling financial sectors and stifling debt burdens in the periphery, but also a decline in German exports—will eventually force the ECB to act more forcefully to ease policy and weaken the euro. Japan is undergoing significant political change, and we view the weakening of its currency and remarkable recent strength of its stock market as leading indicators of better times ahead in that country.
- Yields on safe-haven government bonds remain low, but we believe they will turn out to be poor investments in the next five to 10 years compared to stocks. However, bond yields could continue to trade below our estimate of fair value for some time, as central banks maintain zero-interest-rate policies and households continue to repair their balance sheets. When higher interest rates do finally materialize, equity investors may not be impacted too severely; historical data shows that, when 10-year U.S. Treasury yields are below 5%, rising interest rates are typically associated with rising, not falling, stock markets.
- The fallout from the financial crisis and the consequences of decisions made then continue to reverberate today. A more direct and activist government role in industrial policy (including finance, industry, healthcare and energy), increased social safety nets, and higher taxation on wealth and income are by-products of the crisis. They may or may not serve a good purpose, but they will surely impede the recovery in private sector economic activity.
- The recent elections in Italy are the latest example of government dysfunction. As the recession drags on, we look for more leadership changes in Europe. This may be a good thing, if more growth-oriented policies are put in place. But the uncertainty that arises as the establishment parties are replaced by something else could unnerve investors in the interim. In our opinion, politics is another reason to underweight Europe in investor portfolios.
- At this stage of the cycle, we expect stock markets to rally on good economic news, even if bond prices react negatively. Of course, there’s enough political and economic uncertainty in the world that it is difficult to make sweeping generalizations even within asset classes. We favor Japanese stocks and remain cautious on European equities and the euro. We are looking to add to our U.S. equity exposure versus bonds on a market pull-back, but it has been a somewhat frustrating wait. While we believe emerging-market equities are attractive in the long term, opportunities for excess return in the near term appear easier to achieve from the bottom up than the top down. In fixed income, we favor shorter-than-benchmark duration. We also favor credit over government debt. We have been neutral on the bond/stock call in the short term, but expect equities to be the better-performing asset over the next five to 10 years.
- A full-length paper is available if you wish to learn more about this timely topic.