April 2012

As we conclude another robust earnings season, media attention has fixated on select weaker economic data, while ignoring economic strength. In the previous two years, global economic activity has slowed as spring arrived in the northern hemisphere. Anticipating a third consecutive year of second quarter weakness, investors over the last six weeks have reacted by selling stocks and buying Treasury notes. Again this year, the insidious phrase “sell in May and go away” is freely offered as a sensible investment strategy. Given that backdrop, the month was characterized by a flight to U.S. Treasury notes, with the Yield-to-maturity of the 10-year note falling 30 basis points, closing out the month at 1.91%.

Indeed, the list of potential stock rally-ending events is worrying. The ongoing fiscal and growth issues in Europe are first and foremost. From the continent, fears include of the willingness and ability of Spain and Italy to close their yawning budget deficits without sending the European south into a deep recession. Also of concern is the willingness of Francois Hollande, the newly elected President of France, to follow the path of economic unity established by former President Sarkozy and German Chancellor Merkel. Yet another worry, though to a much lesser extent, is the ongoing problems in Greece. With the country lacking leadership, the risk of an exit from the Euro is rising, although the damage would be minimal compared to the risk that existed last year. Offsetting those concerns, the risk that the European banking sector posed last year has been mitigated by the Long Term Repo Operation funding implemented by the European Central bank.

While investors grappled with fear that economic growth in Europe would spillover to the United States, the Federal Reserve expressed a less accommodative tone and suggested that the possibility of a third round of quantitative easing was less likely. At the conclusion of the April 25th Federal Open Market Committee meeting, Chairman Bernanke described monetary policy “as being approximately in the right place at this point.” Moreover, the committee was quoted as seeing “some signs of Improvement” in the housing sector with the expectation that housing activity would “pick up gradually.” In addition to less accommodative language, the forecasts presented by the Federal Reserve members reflected an upgraded expectation for economic growth. Their forecast for the unemployment rate at year-end 2012 is now 7.8% to 8.0%, a significant reduction from the 8.2% to 8.5% forecast that was presented in January. Even more surprising was the change in their Fed Funds forecast. The Chairman continues to guide investor perception to a 0.25% Fed Funds rate until late 2014. However of the 17 forecasts, only 4 members now expect Fed Funds to remain at 0.25% through 2014 and only 7 members forecast a rate below 1.0% at that time.

Also commanding attention has been a marginal slowdown in economic activity that began in March and continued through April. It now appears that the mild winter pulled activity forward at the expense of second quarter growth. The most glaring example is the slowing rate of job creation. After adding an average of 250,000 jobs in December, January, and February, job growth over the last two months has been 166,000 and 130,000 respectively. We believe that the slowdown in job creation will be temporary and are already seeing evidence of improvement in the weekly unemployment insurance claims rate. After spiking briefly in April, initial claims have again drifted lower, seemingly indicating that job growth is again gaining steam. Another measure of the job market is the Jobs Openings and Labor Turnover Survey, known as JOLTS. The JOLTS survey presents the total number of jobs currently available but not yet filled. In March that figure climbed to 3.737 million jobs, the highest level since July 2008. Digging deeper into the report every category, save government, saw an increase in help wanted.

As we commence this month, we think to sell in May, or to buy into the Treasury rally, would be a mistake. Economic activity continues to improve with the housing market showing signs of bottoming, gas prices have eased, and U.S. manufacturing continues to enjoy a renaissance. Moreover, as the Federal Reserve’s manipulation of Treasury note prices concludes at the end of June, a very large marginal buyer will exit the market. We wouldn’t be surprised to see investors sell Treasury securities in advance of the end of that program. Certainly, investors will continue to be subject to heightened volatility caused by “tape bombs,” as market moving bad news is known on Wall Street. However, we don’t expect that to derail the accelerating recovery in the United States.