A weak end to a turbulent quarter
March ended with U.S. indices down, as the Dow Jones Industrial Average, S&P 500 Index, and Nasdaq declined 1.85 percent, 1.58 percent, and 1.26 percent, respectively. After brief gains at the start of the month, markets moved lower and remained there for most of March.
Weak economic reports hit the market during the month, with declines in personal spending and vehicle sales in early March setting the tone. Weak retail sales reported later in the month preserved the downbeat atmosphere, despite the strong employment growth reported.
For the first quarter as a whole, the news was better, with U.S. markets reporting gains in the face of weak March results. At quarter-end, the Dow had a marginal gain of 0.33 percent, while the S&P 500 did somewhat better, gaining 0.95 percent. The Nasdaq was the winner for the quarter, up 3.48 percent, on strong results in technology and biotechnology stocks.
Fundamentals were weak during the quarter, as earnings projections dropped for the first half of the year. Between the strong dollar, which adversely impacted foreign sales and profits, and the collapse in oil prices, which hammered energy companies, first- and second-quarter earnings estimates went negative, although growth estimates for the second half of 2015 remain strong. Declining growth expectations—combined with rising perceptions that first-quarter U.S. growth would also be below expectations, as well as speculation about the timing of a pending Federal Reserve (Fed) increase in short-term interest rates—made investors more cautious.
Technical factors were generally strong, although the Dow and S&P 500 closed the quarter close to their 100-day moving averages, and markets closed the quarter well above levels that could be considered red flags.
International markets performed similarly for the month, though much better for the quarter. The MSCI EAFE Index was down 1.52 percent in March but up a much stronger 4.88 percent for the quarter based on indications of a nascent recovery in the European economy. The MSCI Emerging Markets Index was down 1.59 percent for the month but up 1.91 percent for the quarter. Both indices benefited from an improved trade position, as the U.S. dollar strengthened.
Technical factors were weak for international markets during most of the quarter, although they improved toward quarter-end. Developed international markets closed above their 200-day moving averages at the end of March. In addition, although the emerging markets index spent most of the three-month period below this critical level, at quarter-end it was moving back up and getting close to its 200-day moving average. Arguably, this could be considered a positive sign for international markets going forward.
Within fixed income markets, March showed significantly different results in different sectors. The Barclays Aggregate Bond Index had another strong month, up 0.46 percent and capping a gain of 1.61 percent for the quarter. But weakness in the energy sector, weighed on the high-yield sector, a previous outperformer; the Barclays Capital U.S. Corporate High Yield Index posted a 0.55-percent loss for the month despite gaining 2.52 percent for the quarter.
U.S. economy takes a winter nap
A principal cause of the March decline in U.S. markets was a series of poor economic reports during the quarter. Personal spending dropped, driven by declines in vehicle and retail sales. Business investment also dropped, with spending on durable goods down as well. Another factor driving weakness was the effect of the strong U.S. dollar, which hit exports and drove factory activity down. Manufacturing surveys also indicated lower business confidence.
Probably the biggest negative economic data, though, was the March employment report, which showed job growth well below expectations, at 126,000, along with downward revisions to the previous two months. Employment had been the one area of the economy that had continued to perform strongly, so this weak report was concerning.
But the weak data notwithstanding, the underlying trends continued positive. Job growth over the past year has remained above the highest level of the mid-2000s and consistent with the late 1990s (see chart). Other data suggests that the employment market remains strong, with voluntary quits at a seven-year high and the unemployment rate, at 5.5 percent, approaching normal levels. Moreover, initial jobless claims as a percentage of the labor force have dropped to the lowest level on record. Robust job growth has also led to strong growth in personal incomes, up a healthy 0.4 percent at the end of March.
Total Nonfarm Employment, All Employees, 1995–2015
Despite the gap between income growth and spending, fundamentals remain strong. In fact, as the savings rate rises, the sustainability of the recovery actually becomes stronger.
Housing also showed improvement during the quarter. Sales volume for new and existing homes ticked up during March, despite snow and cold weather in the Northeast. Moreover, prices continued to increase for new and existing homes, suggesting that demand is still strong. Although the data has been mixed, the overall conclusion is that, despite some seasonal weakness and supply factors, the housing market remains healthy.
Another indicator that the slowdown in the U.S. economy was weather related was the increase in consumer confidence. At the end of March, the Conference Board's consumer confidence number was still close to a six-year high, recovering some of February's decline and suggesting improved consumer and economic demand over the next several months.
An interest rate rise may be on the horizon
Speculation over when—and whether—the Fed would increase short-term interest rates was another factor driving uncertainty during March. Even though the improving employment situation led many to expect rates to rise sooner rather than later, persistently low inflation numbers led others to expect the Fed to hold rates at low levels. The Fed statement, released in March, split the difference, removing the word "patient" from the language used but leaving open the possibility of rate increases at or after the Federal Open Market Committee's (FOMC's) June meeting. Despite some carefully nuanced language, however, notes released after the March Fed meeting indicated that the FOMC believes the economy is continuing to strengthen, providing a reason for optimism about the future.
International risks take a break
One reason for the strong performance of international equities for the quarter, despite the March weakness, was the perception that geopolitical risks are slowly decreasing. The Russian occupation of parts of Ukraine has moved off the headlines, while Iran and the U.S. are reportedly close to a deal to resolve concerns about Iran's nuclear program.
Economic issues have also started to recede, with the European Central Bank's decision to start a stimulus program reassuring investors, as the European economies have shown increasingly positive results. And even Greece appears to be on its way to at least a temporary resolution, with the new government entering contentious, but so far productive, negotiations with the rest of the eurozone. Moreover, the Chinese government has been slowly implementing various stimulus programs in response to weaker-than-expected growth.
Overall, although risks remain—primarily in the political sphere—the perception of investors has increasingly moved toward looking for opportunity rather than risk.
Spring coming soon
It appears that the U.S. economy will likely continue, and perhaps accelerate, its recovery, as global risks also become less of a concern. At the same time, however, risks remain on the financial side. With interest rates still close to record lows—and stock prices at record highs—even continued good news could leave us vulnerable to price volatility, as March has shown.
In fact, good news on the economic side may already be reflected in financial asset prices. And an argument can be made that the political risks, as well as the remaining economic risks, are not fully priced in.
Given this uncertainty, investors should maintain a long-term focus to maximize their chances for success. Despite the positive news on the economic front, risks do remain, and a properly diversified portfolio is still the best solution for achieving those long-term financial goals.
Authored by Brad McMillan, senior vice president, chief investment officer at Commonwealth Financial Network.
All information according to Bloomberg, unless stated otherwise.
Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Barclays Capital U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below.