Over the last 2 1/2 months the markets have been very interesting, to say the least. We’ve seen the beginning of what most people believe is the transition between portfolio flows from only fixed income to a more balanced approach that includes equities and multi-assets. All of a sudden fixed income, which was once perceived to be a less risky asset class, produced some negative returns and heightened volatility. In fact, there has been more volatility in the fixed income market some days than in the equity markets. So clearly, this once-perceived “safe haven” is starting to show some cracks.
A lot of the volatility in the market has been caused by the Fed’s mixed messages with regard to tapering. As economic news continues to be disappointing, everybody expects a recovery to occur in the second half of this year, but so far the recovery has been fairly weak. U.S. GDP over the first half of the year was below 2%, weaker than expected. This combined with low inflation has resulted in fairly weak company growth rates. At this point in the reporting season, companies reported revenue growth of 1.2%, which is a weak result in nominal terms.
There Are Some Bright Spots
On the bright side, there have been some better-performing sectors. Financials had strong results, with 74% of the companies beating expectations by a significant margin. The other sector that has been a positive outlier has been healthcare, again with very strong earnings, and we are hopeful for further improvement.
So if the GDP and corporate earnings are so weak, why is money pouring into the equity markets? The reason is twofold
• The government continues to pump money into the economy
• The overall market sentiment is very bullish
Honestly, it’s more sentiment than anything else that is fueling this inflow into equities. On the corporate side, earnings aren’t growing as expected, but multiples are. As we move along toward the end of the year I think this rally can accelerate, but only if we get any real sign of GDP growth acceleration. Before that, corrections are likely to occur.