Waddell & Reed

Market Perspectives


Key points for mid-year planning

Story Highlights

  • In our view, through the second half of 2013, the economic outlook for the U.S. is one of moderate growth and low inflation.
  • On a long term basis, it appears that equities are going to outperform relative to bonds on a total return basis. The mid-year market turmoil highlighted that reality.
  • Recent data suggest that the Euro zone is starting to stabilize, although it is still very early in that process.
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Investment Team

Manager Name

Hank Herrmann

CEO

With confusing comments from the Federal Reserve, ongoing unrest in the Middle East, concerns about security leaks and political bantering, it’s easy to overlook the fact that the S&P 500 Index increased nearly 13 percent year-to-date by the end of June. Nonetheless, the financial markets felt a bit uneasy as we moved into the second half of the year.

 

While economic fundamentals in the U.S. remain fairly sound, volatility remains present across the globe. This was most evident in the U.S. in late May, when Federal Reserve Chairman Ben Bernanke discussed Fed’s outlook and position, broadly referring to the possibility of tapering the amount of monetary expansion it supported through its bond-buying program. The appearance of explicit guidelines surprised the markets and caused a severe sell off around the world and a sharp rise in interest rates.

The Fed commentary caused such turmoil at the time because it appeared incongruous relative to the Fed’s ultimate goals of reducing the jobless rate and sustaining inflation at 2 to 2.5%. Ironically, the comments in fact created some uncertainty about the sustainability of the strength of the U.S. economy. After observing the reaction, the Fed embarked on a program to soften the comments, saying that the timing of any tapering of bond purchases would be data-dependent and was not pre-determined. Consequently, the bond markets have stabilized, while equity markets have mostly recovered. It continues to be uncertain exactly when and what action may be coming from the Fed as they analyze ongoing data.

Reading beyond the Fed lines:

In our view, through the second half of 2013, the economic outlook for the U.S. is one of moderate growth and low inflation. Our outlook is essentially unchanged from the beginning of the year. We’re looking for low inflation, approximately 1.5 to 2.0% or so, and gross domestic product (GDP) growth in the U.S. of around 1.5 to 2.0%. If this holds true, there seems to be little reason for the Fed to stray from present stimulus policies.

“Dividend growth now may be a better place to focus, rather than just on income.”
 

An important factor to achieving moderate or better growth is the employment picture. Job growth needs to stay around or above 175,000 per month. While the June data was above that, the numbers have not been consistently that strong this year. GDP growth has been below 2%, as has inflation. If anything, given the Fed’s goals and recent data, the argument could be made that more accommodation could be justified, not less. The data surrounding other economic issues remains positive, including manufacturing, housing, auto sales and consumer spending. All of this is supportive of the U.S. equity markets

Main issues at mid-year

As we look ahead, there are several points that we feel are important for advisors and investors to keep in mind. Among them:

  • As long-term interest rates slowly rise in the U.S., investors have begun to move away from bonds and toward equities. We believe this shift slowly will continue as investors seek higher returns.
  • On a long term basis, it appears that equities are going to outperform relative to bonds on a total return basis. The mid-year market turmoil highlighted that reality.
  • While dividend-yielding stocks performed well in the first half of this year, dividend growth now may be a better place to focus than just on income. Cyclical stocks that pay good dividends should remain attractive.
  • Emerging economies around the world appear to be in a slowing or contracting mode. China, the driving growth story, is in an important slowdown mode. The ripple effects are cascading onto the shores of the rest of the emerging world. China will still see growth, but at a slower pace than in the past, perhaps 6 to 7% GDP.
  • Japan saw strong growth in the first half of the year and, although it also has seen some volatility, the aggressive stimulus efforts undertaken by Prime Minister Shinzo Abe appear to be working. The country still has some fiscal imbalances, but we are finding undervalued companies there that continue to provide investment opportunity.
  • Recent data suggest that the Euro zone is starting to stabilize, although it is still very early in that process. A sustained recovery there remains elusive, and recession is still statistically possible. However, annual inflation in the Euro zone in June was only 1.6%, providing room for further stimulative monetary policy initiatives.
  • In a relative sense, the U.S. economy currently appears to be on firmer footing than other parts of the world. We continue to believe that growth in the U.S. will be driven by three sectors of the market: housing, energy and industrials. As mortgage rates slowly rise along with long-term interest rates, it may temper the growth in housing somewhat, but not significantly at least at this point.

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered to represent the U.S. stock market. Investments cannot be made directly in an index.

Past performance is no guarantee of future results. The opinions expressed in this article are those of Mr. Herrmann and are current through July 2013. Mr. Herrmann’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. Waddell & Reed Financial, Inc. is the ultimate parent company of Waddell & Reed, Inc.

Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for any of the Waddell & Reed Advisors Funds or Ivy Funds, call your financial advisor or visit www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.

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