Bull Market in a Fragile Economy

April 16, 2013

This week's economic data confirm our thesis of a relatively weak U.S. economy as we head into the spring.
-John Bonnell, AVP of fixed income portfolios, USAA Investments

The good news for diversified investors is that the S&P 500 hit a new high this week. The bad news is that despite investor bullishness the U.S. economy is showing signs of sputtering. The S&P 500 index set a new all-time closing high Thursday, and ended the week at 1,589, up 2.33% from last Friday. Treasury bonds were mixed, with the yield on the 10-year rising 0.01 of a percentage point to close the week at a 1.72% yield.

Commodities sold off sharply Friday. For the week, oil declined 1.5% and gold plunged 6.1% and broke below the $1,500 level for the first time since June 2011. It closed at $1,483. Gold mining equities also continued their precipitous decline, ending the week lower by 8%, pushing the year-to-date decline to -30.21%. A possible reason for the decline may be the news that Cyprus plans to sell gold reserves to raise additional cash.

First-quarter earnings season kicked off this week, with Alcoa reporting a better-than-expected quarter. Consensus estimates call for 1% year-over-year earnings growth for the S&P 500 index for the first quarter, and accelerating to 15% by the fourth quarter. We view the expectations for second-half acceleration as optimistic, given the fact that profit margins are at an all-time high, combined with estimated before-inflation economic growth of sub-5% in the developed economies.

This week's economic data confirm our thesis of a relatively weak U.S. economy as we head into the spring. March retail sales unexpectedly dropped by 0.4%, and the University of Michigan consumer confidence index plunged to a recessionary 72.3 reading, the lowest since last July.

Next week, investors will be focused on earnings reports. Key releases scheduled include Citigroup, American Express, Coca-Cola, Goldman Sachs, Microsoft and Intel, among others. In terms of economic releases, we think the Empire State Manufacturing Survey, industrial production and housing starts will garner the most attention from investors.

We maintain our cautious outlook for the U.S. economy and equity markets, given the high built-in expectations, and have positioned our managed portfolios for a minor correction in equity markets. However, we recognize that the four largest developed markets (eurozone, United Kingdom, Japan and the U.S.) are united in the largest expansion of monetary policy in recent history. As a result, we will seek to capitalize on periods of heightened volatility to prudently add risk back into our managed portfolios.


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