In Manning & Napier's spring commentary, they discuss how the economy is still being restrained by certain factors, and they still favor corporate bonds:
As the first quarter of 2012 comes to a close, it is becoming more evident that the U.S. economy has gained traction and organic growth is putting down roots. Domestic labor markets took another encouraging step forward in January. Nonfarm payrolls grew by a net 243,000 after backing out 14,000 government positions that were eliminated in the month. Gains were widespread across employment sectors, and the unemployment rate shrank to 8.3%. Relative to investors' expectations, these latest employment figures were good. That being said, the sustainability of improvements in the labor markets and the broader economy remain a concern. Last year, a series of exogenous shocks undermined investors' confidence and threatened to derail the nascent domestic economic expansion. The U.S. is not immune to these types of shocks today, but the economy appears to be strengthening within the overall slow growth backdrop.
Rising tension in the Middle East is once again being reflected in higher global oil prices and higher domestic gasoline prices. In fact, gasoline prices in the U.S. recently touched their highest level ever for this time of year. As we discussed last year when commodity prices were rising, higher prices at the pump act like a tax on consumption. They also negatively influence consumer sentiment. While it may be true that the U.S. economy is on firmer footing today than at any point since the last recession, certain aspects of the economy remain far from robust and domestic growth is still susceptible to shocks. Consumers have certainly made progress toward paying down debts and repairing their balance sheets, yet they still lack the wherewithal and broad-based confidence to become a more meaningful economic growth contributor. To the extent that tensions in the Middle East remain elevated and continue to drive gasoline prices higher, wage gains created by improving labor market fundamentals may get eroded. Ultimately, higher gas prices could be an additional burden on the still fragile U.S. consumer – an example of a potential headwind facing the U.S. economy.
So far this year, progress in the domestic economy has largely exceeded investors' expectations, but January's retail sales report was one exception. Retail sales grew a lower than anticipated 0.4% in January, and the monthly gain for December was revised down slightly. While still generally good, these retail sales figures serve as a subtle reminder that there are a number of forces present today that are restraining growth, and some may become more problematic than others in the short-run (i.e., gasoline prices). With this in mind, we continue to expect slow growth going forward.
The Global Economy
European developments remained front page news in February. Last month, Moody's lowered the credit ratings it ascribes to six countries including Italy, Spain, and Portugal. Fitch ratings also reduced Greece's sovereign credit rating to a lower junk status, as the nation continued to struggle to secure a much needed installment of bail-out funds. Interestingly, the recent wave of ratings downgrades has done little to deter investors' renewed appetite for government bonds from some of the larger peripheral nations. In fact, yield spreads over German bunds (i.e., the German equivalent of U.S. Treasury bonds) in Italy and Spain have stabilized since late November. It appears that recent substantial expansion in the European Central Bank's balance sheet has made noteworthy strides in calming market fears by reducing the potential for worst case outcomes. Economic growth across the Eurozone remains under pressure as the more fi scally stretched regimes implement austerity measures, but recent indications from some of the stronger nations could help support activity in the region more broadly. France's economy expanded in the fourth quarter of 2011 (albeit modestly), while other European nations suffered contraction. Germany's economy has also served as a bellwether of strength in the Eurozone amid the ongoing sovereign debt crisis.
Over the past six months, we've seen a fl urry of policy-easing maneuvers take shape around the globe. In February, China's central bank announced a cut to the amount of money it requires banks to hold as reserves for loan losses. The move will reduce the Reserve Requirement Ratio (RRR) in China by 50 bps to 20.5% and is expected to free-up money for new lending to help keep China's economy growing at a healthy rate.
Inflation
Current trends in the U.S. consumer price index (CPI) continued into the new year. The annual CPI measure decelerated in January to 2.9% from 3.0% in December. Meanwhile, excluding food and energy components, core consumer prices accelerated slightly to 2.3% year-overyear through January. Core prices had risen at a 2.2% pace in the twelve months through December. While January's core infl ation reading is slightly above the Federal Reserve's 2% target, we do not believe a monetary policy response is likely in the near term. The Fed's 2% inflationary target is a long-term goal, and recent commentary from the central bank shows that policymakers are focused on promoting growth and improving the employment picture in the current environment.
Inflationary pressures outside the U.S. continue to abate as well. Headline infl ation in the United Kingdom decelerated to 3.6% in the year to January from 4.2% the prior month. The pace of price increases has been running above the Bank of England's (BOE) 2% target since December 2009, but there too rate-setters have kept borrowing costs at record low levels and recently approved another monetary stimulus in response to weakening growth. Recent figures showed the U.K. economy contracted 0.2% in the last three months of 2011.
The current fixed income landscape is anything but normal. With U.S. short-term interest rates hovering near zero, and longerdated Treasury yields near multi-decade lows, income generation has become more difficult to achieve. Additionally, the risk adverse environment has resulted in a general "flight to quality" as investors have flocked toward "safer" assets such as Treasuries. Such dynamics are creating certain challenges in the fixed income investment universe. However, distinct opportunities exist as well.
Generally, Treasuries are the first thing to come to mind when most people think of fixed income, and they make up a substantial portion of the main fixed income indices. However, Manning & Napier does not feel Treasuries offer substantial fundamental value today. Indeed, a closer look at the fundamentals in the Treasury market exposes multiple potential concerns. With yields already near historic lows, there is arguably a greater risk that yields/interest rates will move higher over the long run. Given the inverse relationship between bond prices and yields, that means Treasury prices appear poised to fall over time. Furthermore, the increasing size of the U.S. deficit creates potential pressure for the Treasury market down the road. Overall, while Treasuries may have benefited from the fear-driven environment in 2011, from a fundamental perspective, Treasuries appear to have more headwinds than tailwinds today. Accordingly, we continue to prefer U.S. Agency securities (i.e., FannieMae and Freddie Mac) over Treasuries in the current environment.
In light of this outlook, Manning & Napier also favors corporate bonds whose yields trade at a spread above Treasury yields. In fact, corporate bonds are currently among the heaviest weightings in both Series. Corporate America is relatively healthy today, and companies in general have been earning strong profits with healthy profit margins. Further, many corporations have been taking advantage of low interest rates to refinance or access the bond market for fresh capital. In our opinion, these conditions, along with the generally risk adverse market environment, are creating attractive investment opportunities in the corporate bond market. In particular, we see several main reasons corporate bonds present compelling investment opportunities in today's environment. First, the spread between corporate bond yields and Treasury yields remains attractive, although below the peak levels typically seen during times of crisis. In general, a wide credit spread represents substantial reward potential and the ability to outperform Treasuries. Next, we expect default rates to remain moderate as the quality of corporate bond issuers has improved coming out of the recent credit crisis. Additionally, economic indicators continue to point toward slow growth, which should generally be supportive for the corporate bond market. Finally, given the current market environment, the appetite for income is likely to contribute to strong demand for some time.
The corporate bond market consists of both investment grade and high yield (i.e., below investment grade) corporate bonds. In the more flexible Core Plus Bond Series, we are also finding compelling opportunities in the high yield sector for similar reasons as in the investment grade corporate sector. While high yield bonds typically have greater risk and a higher default rate than their investment grade peers, in return for the added risk, the high yield sector typically offers some of the highest potential rewards in the fixed income market; high yield bonds have historically generated equity-like returns with lower volatility.
As fixed income markets continue to evolve, we believe it is critical to remain focused on the fundamentals. With this mindset, Manning & Napier continues our commitment to an active investment approach. Through a fundamentals-based investment strategy, Manning & Napier strives to provide competitive absolute and relative returns by taking advantage of market opportunities and managing risk over the full market cycle.
Sources: Bloomberg, Associated Press, FactSet, Financial Times, Yahoo! Finance.
Analysis: Manning & Napier Advisors, LLC (Manning & Napier). All investments contain risk and may lose value. This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
As the first quarter of 2012 comes to a close, it is becoming more evident that the U.S. economy has gained traction and organic growth is putting down roots. Domestic labor markets took another encouraging step forward in January. Nonfarm payrolls grew by a net 243,000 after backing out 14,000 government positions that were eliminated in the month. Gains were widespread across employment sectors, and the unemployment rate shrank to 8.3%. Relative to investors' expectations, these latest employment figures were good. That being said, the sustainability of improvements in the labor markets and the broader economy remain a concern. Last year, a series of exogenous shocks undermined investors' confidence and threatened to derail the nascent domestic economic expansion. The U.S. is not immune to these types of shocks today, but the economy appears to be strengthening within the overall slow growth backdrop.
Rising tension in the Middle East is once again being reflected in higher global oil prices and higher domestic gasoline prices. In fact, gasoline prices in the U.S. recently touched their highest level ever for this time of year. As we discussed last year when commodity prices were rising, higher prices at the pump act like a tax on consumption. They also negatively influence consumer sentiment. While it may be true that the U.S. economy is on firmer footing today than at any point since the last recession, certain aspects of the economy remain far from robust and domestic growth is still susceptible to shocks. Consumers have certainly made progress toward paying down debts and repairing their balance sheets, yet they still lack the wherewithal and broad-based confidence to become a more meaningful economic growth contributor. To the extent that tensions in the Middle East remain elevated and continue to drive gasoline prices higher, wage gains created by improving labor market fundamentals may get eroded. Ultimately, higher gas prices could be an additional burden on the still fragile U.S. consumer – an example of a potential headwind facing the U.S. economy.
So far this year, progress in the domestic economy has largely exceeded investors' expectations, but January's retail sales report was one exception. Retail sales grew a lower than anticipated 0.4% in January, and the monthly gain for December was revised down slightly. While still generally good, these retail sales figures serve as a subtle reminder that there are a number of forces present today that are restraining growth, and some may become more problematic than others in the short-run (i.e., gasoline prices). With this in mind, we continue to expect slow growth going forward.
The Global Economy
European developments remained front page news in February. Last month, Moody's lowered the credit ratings it ascribes to six countries including Italy, Spain, and Portugal. Fitch ratings also reduced Greece's sovereign credit rating to a lower junk status, as the nation continued to struggle to secure a much needed installment of bail-out funds. Interestingly, the recent wave of ratings downgrades has done little to deter investors' renewed appetite for government bonds from some of the larger peripheral nations. In fact, yield spreads over German bunds (i.e., the German equivalent of U.S. Treasury bonds) in Italy and Spain have stabilized since late November. It appears that recent substantial expansion in the European Central Bank's balance sheet has made noteworthy strides in calming market fears by reducing the potential for worst case outcomes. Economic growth across the Eurozone remains under pressure as the more fi scally stretched regimes implement austerity measures, but recent indications from some of the stronger nations could help support activity in the region more broadly. France's economy expanded in the fourth quarter of 2011 (albeit modestly), while other European nations suffered contraction. Germany's economy has also served as a bellwether of strength in the Eurozone amid the ongoing sovereign debt crisis.
Over the past six months, we've seen a fl urry of policy-easing maneuvers take shape around the globe. In February, China's central bank announced a cut to the amount of money it requires banks to hold as reserves for loan losses. The move will reduce the Reserve Requirement Ratio (RRR) in China by 50 bps to 20.5% and is expected to free-up money for new lending to help keep China's economy growing at a healthy rate.
Inflation
Current trends in the U.S. consumer price index (CPI) continued into the new year. The annual CPI measure decelerated in January to 2.9% from 3.0% in December. Meanwhile, excluding food and energy components, core consumer prices accelerated slightly to 2.3% year-overyear through January. Core prices had risen at a 2.2% pace in the twelve months through December. While January's core infl ation reading is slightly above the Federal Reserve's 2% target, we do not believe a monetary policy response is likely in the near term. The Fed's 2% inflationary target is a long-term goal, and recent commentary from the central bank shows that policymakers are focused on promoting growth and improving the employment picture in the current environment.
Inflationary pressures outside the U.S. continue to abate as well. Headline infl ation in the United Kingdom decelerated to 3.6% in the year to January from 4.2% the prior month. The pace of price increases has been running above the Bank of England's (BOE) 2% target since December 2009, but there too rate-setters have kept borrowing costs at record low levels and recently approved another monetary stimulus in response to weakening growth. Recent figures showed the U.K. economy contracted 0.2% in the last three months of 2011.
The current fixed income landscape is anything but normal. With U.S. short-term interest rates hovering near zero, and longerdated Treasury yields near multi-decade lows, income generation has become more difficult to achieve. Additionally, the risk adverse environment has resulted in a general "flight to quality" as investors have flocked toward "safer" assets such as Treasuries. Such dynamics are creating certain challenges in the fixed income investment universe. However, distinct opportunities exist as well.
Generally, Treasuries are the first thing to come to mind when most people think of fixed income, and they make up a substantial portion of the main fixed income indices. However, Manning & Napier does not feel Treasuries offer substantial fundamental value today. Indeed, a closer look at the fundamentals in the Treasury market exposes multiple potential concerns. With yields already near historic lows, there is arguably a greater risk that yields/interest rates will move higher over the long run. Given the inverse relationship between bond prices and yields, that means Treasury prices appear poised to fall over time. Furthermore, the increasing size of the U.S. deficit creates potential pressure for the Treasury market down the road. Overall, while Treasuries may have benefited from the fear-driven environment in 2011, from a fundamental perspective, Treasuries appear to have more headwinds than tailwinds today. Accordingly, we continue to prefer U.S. Agency securities (i.e., FannieMae and Freddie Mac) over Treasuries in the current environment.
In light of this outlook, Manning & Napier also favors corporate bonds whose yields trade at a spread above Treasury yields. In fact, corporate bonds are currently among the heaviest weightings in both Series. Corporate America is relatively healthy today, and companies in general have been earning strong profits with healthy profit margins. Further, many corporations have been taking advantage of low interest rates to refinance or access the bond market for fresh capital. In our opinion, these conditions, along with the generally risk adverse market environment, are creating attractive investment opportunities in the corporate bond market. In particular, we see several main reasons corporate bonds present compelling investment opportunities in today's environment. First, the spread between corporate bond yields and Treasury yields remains attractive, although below the peak levels typically seen during times of crisis. In general, a wide credit spread represents substantial reward potential and the ability to outperform Treasuries. Next, we expect default rates to remain moderate as the quality of corporate bond issuers has improved coming out of the recent credit crisis. Additionally, economic indicators continue to point toward slow growth, which should generally be supportive for the corporate bond market. Finally, given the current market environment, the appetite for income is likely to contribute to strong demand for some time.
The corporate bond market consists of both investment grade and high yield (i.e., below investment grade) corporate bonds. In the more flexible Core Plus Bond Series, we are also finding compelling opportunities in the high yield sector for similar reasons as in the investment grade corporate sector. While high yield bonds typically have greater risk and a higher default rate than their investment grade peers, in return for the added risk, the high yield sector typically offers some of the highest potential rewards in the fixed income market; high yield bonds have historically generated equity-like returns with lower volatility.
As fixed income markets continue to evolve, we believe it is critical to remain focused on the fundamentals. With this mindset, Manning & Napier continues our commitment to an active investment approach. Through a fundamentals-based investment strategy, Manning & Napier strives to provide competitive absolute and relative returns by taking advantage of market opportunities and managing risk over the full market cycle.
Sources: Bloomberg, Associated Press, FactSet, Financial Times, Yahoo! Finance.
Analysis: Manning & Napier Advisors, LLC (Manning & Napier). All investments contain risk and may lose value. This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
