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Late May Market Check

05/31/2013

Even with last week's Fed-led jitters, the S&P 500 has managed to stay above 1600 since breaking through four weeks ago. The rally virtually no one believed in has moved investors to return to equities, and equity mutual fund flows have turned positive after several quarters, indeed years, of net redemptions. On investors’ minds: How much longer will the rally last?

While "sell in May and go away" worked well the previous three years, that was concurrent with truly deteriorating economic data and European debt woes. In 2013, the global economy is not robust by any measure but is better than feared, and while Europe is still a mess, yields on both Italian and Spanish debt remain on either side of 4%. That is remarkable, considering last summer’s market swoon when yields on the 10-year paper in both countries approached 7%.

We are a long way from sanguine that the rally will strengthen, however, we still believe a high level of equity commitment is warranted based on a combination of monetary stimulus, ongoing positive momentum, and a lack of overt bullishness among the investment community.

Consider the following:

  • Central bank easing – Just about every key central bank on the planet seems to have an easy-money policy. The Fed’s quantitative easing may or may not have much economic impact, but it has certainly been a boon for equities. The Bank of Japan’s support of "Abenomics" is having a desired effect, weakening the yen and revitalizing that economy. The ECB continues to ease, and even the allegedly conservative Royal Bank of Australia recently got in on the game by cutting rates, along with South Korea’s central bank.
  • GDP better than expected – The budget sequester has likely had some negative effect on GDP, as has reduced government spending in general. Government jobs are being furloughed, which is being made up for by the private sector, even if tepidly for this stage of a recovery. Tax receipts are actually coming in stronger than expected, while government outlays are falling slightly. Whether or not this will lead to lower deficits for any meaningful period is yet to be seen, but at a minimum, the news on the budget front is better than most would have expected. To the degree that the private sector can make up the modest cuts in government spending, GDP will increase and the specter of the "government going bankrupt" will recede, at least temporarily.
  • Housing trumps manufacturing slump? – A real area of concern remains the stall in global PMI (purchasing managers' index) data, an early indicator of industrial output and thus economic growth. By no means is the manufacturing sector falling off a cliff like it did in 2008 – or even seeing anything like the decline experienced in the spring/summer of 2011 and 2012 – but it bears watching. Working in the economy’s favor are higher home prices, increasing construction activity, lower gasoline prices, and better stock values, all of which have combined to push both consumer confidence and consumer comfort levels to new recent highs. The virtuous circle of confidence-spending growth seems to be accelerating, and that is supportive of higher equity prices.
Finally, it is our view that many market participants misinterpreted Fed Chairman Bernanke’s testimony and statements to Congress last week regarding the future of the Fed’s asset purchases.  At heart, Mr. Bernanke is an academic, with particular expertise in the follies made by monetary authorities during the Great Depression.  His comments regarding a slowing of Fed balance sheet expansion should be taken in the broader context of desired job growth. If, indeed, there is greater economic expansion and concurrent job growth, that is great news for equities, regardless of potential tapering by the Fed. Until there are true signs of growth, the Fed will be slow to end quantitative easing. This is a primary lesson any student of the Depression recognizes. "Helicopter Ben" won’t derail the recovery by tightening too soon.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.