Market Sector Update
- The Fed announced its intention to begin reducing the level of the securities purchased with its quantitative easing policy by $10 billion from $85 billion to $75 billion a month.
- While October began to see some renewed strength in the U.S. economy, we saw a surprisingly strong acceleration in November and December. Durable goods orders and real consumer spending were stronger than expected. New home sales for the last six monthsa were revised sharply higher.
- Third quarter gross domestic product (GDP) estimates were progressively revised higher during the quarter, and upward revisions were also made to core retail sales, industrial production and payrolls. There have been no visible signs of any reversal of this trend through the end of the year.
- Given the sharp narrowing of the U.S. trade gap for the second consecutive month, consensus fourth quarter GDP estimates have been revised up to 2.5%. The risk to the estimate is clearly on the upside and the fourth quarter GDP could ultimately finish much stronger than anticipated.
- High-grade corporate bonds significantly outperformed Treasury debt, agency debentures and agency mortgagebacked bonds over the last three months. Due to the improved economic conditions in the U.S. over the last few months, lower rated bonds have outperformed very highly-rated debt as investors have an increased willingness to take on more risk in their portfolios.
- We have been overweight corporates over the last few years and will continue this overweight position into 2014. With economic conditions improving in the U.S. we could see continued narrowing of corporate bond spreads.
- Our mortgage holdings are structured to experience less extension risk during periods of rising interest rates. Given the sharp rise in the 10-year portion of the yield curve these holdings have performed well relative to Treasury debt.
- Agency mortgage bonds provide a stable source of income for the portfolio. 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 remain overweight high-grade spread product. We are committed to seek stable income at the best available price.
- For the first time in years there is a multi-year budget deal out of Washington that will remove a major headwind from the economy.
- The major risks for 2014 lie in the potential impact higher Treasury bond interest rates will have on China and the emerging markets. Another risk is the unknown costs associated with the implementation of the Affordable Care Act.
- With the short end of the yield curve anchored by the low fed funds rate, we may see continued volatility in the middle and longer end of the curve. Slight changes in the U.S. economic outlook can have significant short effects on longer duration securities.
- The market does not anticipate the Fed to begin raising the fed funds rate until late 2015. In the past, sustained bond bear markets have not been able to get underway until the Fed tightening cycle is imminent.
- We have lowered our exposure to duration risk. We will remain short our benchmark duration going into 2014. We anticipate continued demand for spread product within the high grade bond market. We are willing to take additional credit risk when we believe we are being compensated to do so.
The opinions expressed in this commentary are those of the Fund’s manager and are current through Dec. 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. 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 financial advisor or visit us online at www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.