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The first half of 2012 turned out to be pretty good for returns, despite the rollercoaster ride. We started out strong, had a fairly severe correction, but by the end of the second quarter, both the stock and bond markets were actually up. The S&P 500 finished the first half up more than 9%. Its clear the U.S. economy lost the good momentum it had in the first quarter and seems to have stabilized at a lower level. Everyone is aware of the “fiscal cliff” in Europe. But while there are still many unresolved problems, I believe the bad news is pretty much priced into the market. Of course, if Spain defaults or another major unexpected event happens, its back to the drawing board. But, again, a lot of the tail risk is well known. So what now?
Weakness, but Firming Stability in the Economy
Most of our weakness, particularly in manufacturing, is due to the headwinds from Europe and the lag effects of weakness in Asia from earlier central bank rate tightenings, although weve begun to see stabilization there, too. Consumer spending in the U.S. seems stable, and it looks like some of the more important sectors like autos and housing are picking up as well.
Were beginning to see a worldwide move by central banks toward lower rates, which is going to be particularly effective in Asia, where we don’t believe the financial system is broken, as some have suggested. Theres no reason why “easier” money wont work its way quickly and consistently into the banking system, resulting in higher economic activity in Asia. The ECB and some of the peripheral European countries recently eased rates again, and even the Federal Reserve has re-upped for another round of Operation Twist, although that may be less effective than some of the tools other central banks are using.
Overall, the U.S. has had a bit of a slowdown, but I believe were about to see the end of it. Therell be some residual weakness in manufacturing, but we see more stability rather than huge volatility in the markets ahead. The Fed is determined to keep rates very low for a long period of time. Until we see more stability, we believe interest rates will probably continue to be very low or lowered even further.
Potential Opportunity in U.S. Stocks
In a recent call to our National Sales Team, my colleague Marco Pirondini, Head of U.S. Equities, presented an interesting observation on the history of the U.S. stock market. In the last century, 10-year rolling returns for the equity market, as represented by the S&P 500, have been negative in only two periods – for a time in the 1930s and two years in the 2000s (2009 and 2010).* The 10-year rolling return of equities has rebounded and is now positive 5+% as of 6/30/12. Historically, when the equity market has turned from negative to positive, it has stayed positive for extended periods. Well see, of course – as we all know, past market behavior is not a predictor of future results.
*Data represents past performance, which is not indicative of future results.
We believe equity prices are at historic lows compared to bonds (just one indicator: 57% of the stocks in the S&P 500 have a dividend yield that is above the 10-year Treasury yield). and offer investors much more attractive long-term return potential. Well be discussing the topic in greater detail at Pioneer in the coming months.