Equity markets experienced one of the best first quarters in years, with the Dow logging its strongest quarter since 1998.[i] After flirting with record highs for more than a week, the S&P500 finally broke through its 2007 ceiling to close at a new high of near 1,570. For the quarter, the S&P500 gained 10.03%, the Dow increased 11.25%, and the Nasdaq closed up 8.21%.[ii]
What are some of the factors that contributed to the strong market performance we’ve experienced?
Federal Reserve Stimulus Policy
Many analysts agree that the Fed’s quantitative easing policies of rock bottom interest rates and bond purchases have played a significant role in the market surge. With 2012’s QE-infinity program, the Fed essentially promised to continue to buy bonds until unemployment falls below 6.5% (as long as inflation remains tame); this aggressive action gave investors and business leaders confidence, boosting stock and asset prices and increasing consumer spending.[iii]
Robust Domestic Economic Performance
While markets have certainly benefited from Fed policies, there are solid economic fundamentals underpinning much of the recent performance investors have experienced. The U.S. economy is humming along, and there’s reason to hope for strong first quarter GDP growth. Some forecasts put Q1 GDP growth as high as 3.5%, which is a significant improvement from the 0.4% growth we saw in Q4 2012.[iv]
The housing market was a major contributor to economic and market performance last quarter. Housing prices are increasing across most of the country, and a February report shows that permits for future construction increased at the second-fastest pace seen since June 2008.[v] Unemployment has also seen some recent improvement, with the latest report showing that jobless claims decreased in 22 states while wages increased in 42 states, yielding an unemployment rate of 7.7% in February.[vi] Overall, the economy still has a ways to go before it can be considered fully recovered, but the trends indicate that the recovery is continuing at a strong pace.
What factors could spark volatility in the weeks and months to come?
Uncertainty Around Sequestration Debates
While investors have largely shrugged off concerns about the federal budget sequestration that was triggered on March 1, we expect the impact of government budget cuts to drag on markets in the coming quarter. If lawmakers do not come to an agreement, federal spending will drop by more than $40 billion by the end of the year. While we are hopeful that an agreement will be forthcoming once the full effect of sequestration cuts is felt, the uncertainty around the current political stalemate may cause additional volatility.
Turmoil in Europe
The Eurozone debt and economic crisis remains of deep concern to analysts and investors. While the Cyprus banking situation was resolved with a 10 billion euro loan by raiding depositors’ bank accounts, EU officials have set a bad precedent that may have long-term effects on their banking sector.[vii] The IMF issued a recent report warning that ongoing political wrangling and piecemeal bailouts are threatening the stability of the Eurozone and that cooperative, comprehensive action was needed.[viii] Currently, both Italy and Spain are close to needing bailouts, as interest rates on their debt is rising to untenable levels and the political leadership in each country lacks the credibility necessary to push through needed reforms.
It’s important to keep market milestones in perspective; while we are very pleased that the economy is steadily improving and markets are doing well, we know that the music will stop sometime. In the days and weeks to come, markets may experience volatility as investors take profits and wait for good news. Historically, markets have often underperformed in the second quarter after a big first quarter.[ix] Analysts will be closely watching first quarter earnings reports and economic data, along with monitoring Europe for clues on which way the market will go. However, if economic fundamentals remain solid, markets may experience further upside.
While we continue to remain optimistic about market performance in 2013, we counsel our clients to expect some bumps in the road. If you have any questions about your investments or how your portfolio should be positioned for the rest of 2013, please don’t hesitate to contact us. We are always delighted to be of service to you and your family.
Monday: Motor Vehicle Sales, PMI Manufacturing Index, ISM Mfg. Index, Construction Spending
Tuesday: Factory Orders
Wednesday: ADP Employment Report, ISM Non-Mfg. Index, EIA Petroleum Status Report
Thursday: Jobless Claims
Friday: Employment Situation, International Trade
[ii] Source: Yahoo Finance