Market Sector Update
- Economic data in the United States improved in the second quarter after a very disappointing first quarter. While it does appear that the weakness in the first quarter was temporary, the second quarter data were not exactly robust. There were definite improvements in housing, retail sales and automobile sales. The inflation data was well below the 2% target set by the Federal Reserve (Fed).
- Employment data has been very mixed. The economy created an average of 221,000 jobs each month in the second quarter, but wages don’t appear to be rising. The unemployment rate fell to 5.3% in June, but the fall was due to a 0.3% drop in the labor force participation rate, which now stands at 62.6%, the lowest level in the U.S. since the 1970s.
- The U.S. Treasury market continued to be extremely volatile in the second quarter. With a data dependent Fed, each economic data release has tremendous ability to move the market in either direction.
- The 10-year note began the quarter at 1.92% and ended the quarter 43 basis points higher in yield at 2.35%. Early this year, it appeared the bond market was not a believer that the Fed would be able to raise rates in 2015. Now it would seem bond market participants believe that a rate hike is not only possible this year, but probable.
- We shortened duration slightly in the Fund this quarter and lightened exposure to the longer maturities. We feel a shorter duration is the appropriate position in a period of rising rates. We may shorten duration more and hold more cash if we see more risk that rates go higher.
- We have also been adding mortgagebacked securities to the portfolio. While we feel there will be a better time in the future (when rates are higher) to take a larger position in mortgages, we have been adding bonds which have little extension risk when rates rise.
- We expect the Fed to raise rates at their September meeting, provided the economic data continue to show improvement in the third quarter. Fed Chair Janet Yellen has said the rate increases would be small and would be very gradual so as not to be extremely disruptive to the economy and the markets.
- We expect the volatility seen so far in 2015 to continue as each economic data point is assessed in terms of a rate hike. Activity around the world will contribute to the volatility as the U.S. continues to be the safe haven and “flight-to-quality” trades.
The opinions expressed in this commentary are those of the Portfolio's managers and are current through June 30, 2015. The managers' 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. As with any fund, the value of the Portfolio's shares will change, and you could lose money on your investment. An investment in the Portfolio is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Portfolio may fall as interest rate rise. These and other risks are more fully described in the Portfolio'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 f nancial advisor or visit us online at www.waddell.com. Please read the i prospectus or summary prospectus carefully before investing.