Sellwood’s First Quarter 2013 Market Snapshot is available.
First Quarter 2013: Don’t Fight the Fed (or the BoJ)
Investors pushed sequestration worries to the side as the S&P 500 ended the quarter at an all-time record high of 1,569. Improving numbers in the US housing and labor markets helped spark investor enthusiasm, contributing to the 10.6% return over the first three months of the year. Private payrolls continued to expand and housing prices rose steadily upward, while Congress reached a deal in late January to suspend the federal debt limit and alleviate the near-term risk of a potential debt default. World stock markets also rose as confidence grew that Shinzo Abe’s Japanese reflationary policies would succeed.
Not all the headlines for the first quarter were positive, however. The Italian Parliament Election stalemate threatened to derail structural domestic economic reforms, as the country continues to struggle with prolonged recession, high unemployment, and unsustainable public debt levels. The IMF and the European Union engineered a bailout for the island nation of Cyprus in exchange for bank restructuring, public pension cuts, and welfare reform. China’s new leadership indicated that it is looking to cool off the real estate market in the emerging giant, raising concerns that the slowdown in property investment could ripple across the economy.
Federal Reserve minutes released in February suggested internal disagreement on the pace and length of the Fed’s bond buying programs, which have expanded the central bank’s balance sheet to over $3 trillion, a new record. Federal Reserve chairman Ben Bernanke was quick to reiterate that the FOMC remains committed to open-ended bond buying although he was less committal about his future chairmanship as he entered the final year of his second term.
Looking ahead, we see potential concern for the economy and markets when the Fed begins to slow, let alone unwind, its stimulus efforts. Some warning signs of potential future inflation exist, and the Fed’s primary mandate is price stability. While top-line CPI growth has been stable and slow, the prices of such staples as eggs, bread, transportation, housing, milk, and meat are all rising faster than CPI. Eventually, the Fed’s designs on macroeconomic stability will conflict with its goals of price stability, and the associated risks of rising rates that are beyond its control could threaten not just the economic recovery, but the Federal budget. In this context, long-term Treasury rates rose modestly, and most fixed income returns were flat in the quarter.