Market Sector Update
- After starting the year near 1.75%, by mid-March the yield on the 10-year Treasury bond reached 2.06%, testing the 12-month high. A similar pattern occurred with the 30-year which began the year at 2.95% and increased to 3.26% by mid-March. Both benchmarks saw a significant decline in rates at the end of the quarter.
- Following a surprisingly strong jobs report for February and early signs to a stronger than expected U.S. consumer, expectations for growth began to be ratcheted up by many market observers. These expectations faded by the end of March, culminating in a very disappointing jobs report for March.
- Also adding fuel to the recent rally in the Treasury market was the renewed turbulence in the eurozone. In March the eurozone composite purchasing managers index (PMI) declined to 46.5 and retail PMI declined to 43.3. The eurozone unemployment rate increased to a record 12% for February.
- The banking crisis in Cyprus reinforced the flight to quality trade into Treasuries this quarter. Additionally, the Fed continues to aggressively buy both Treasury bonds and agency mortgagebacked securities (MBS). It appears unlikely that the Fed will reduce these purchases anytime soon.
- This fund only invests in very high grade, government-backed fixed income securities. We expect rates to drift lower and intend to keep the portfolio duration slightly long relative to our benchmark.
- The Fed’s continued buying of new issue mortgage-backed bonds has provided a very stable floor to the mortgage market. Agency mortgage bonds provide a stable source of income for the portfolio. Our mortgage holdings benefited from increased market demand following the institution of QE3.
- We continue to look for opportunities to increase our agency mortgage bond exposure. We remain underweight Treasury bonds, especially at the very short end of the curve, and overweight high-grade spread product. Agency debentures offer a marginal spread pickup to treasuries. We are committed to seek stable income at the best available price.
- We continue to see major headwinds to the growth of the U.S. economy. There will be very little, if any, fiscal stimulus this year out of Washington. The division in Washington will only add to the uncertainty and volatility in the financial markets. Inflation should remain under control from now thru 2014. Given the tepid job market recovery, the Fed's quantitative easing will most likely continue well into 2014. Housing should become much less of an economic drag going into 2013.
- The resolution of the fiscal cliff at yearend was little more than kicking the can until later in 2013. Tangible spending cuts must be reached to prevent another circus from erupting in Washington over the U.S. debt limited extension. The last such circus, in July 2011, resulted in huge market price swings and the ultimate downgrading of the U.S. Treasury credit rating. We can only hope that Washington has learned some lessons from that experience.
- Historically, sustained bond bear markets have not been able to get underway until a Fed tightening cycle is imminent. That continues to suggest rates will remain low throughout 2014. Our goal is to maintain the portfolio duration slightly above its benchmark at this time.
The opinions expressed in this commentary are those of the Fund's manager and are current through March 31, 2013. The manager’s views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.
Risk Factors. Fixed-income securities are subject to interest rate risk and, as such, the net asset value of the Fund may fall as interest rates rise. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. These and other risks are more fully described in the Fund’s prospectus.
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 the mutual funds offered by Waddell & Reed, call your financial advisor or visit us online at www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.