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. Inflation 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.
- Investment grade credit spreads widened over the quarter. Bond issuance set another quarterly record at $377.8 billion. While demand for new issues continues to be strong, some fatigue has set in and investors are requiring more spread for taking more bonds.
- 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.
- 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 been overweight investment grade credit and will look to lighten up as opportunities to do so become available.
- 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.
- We expect investment grade credit issuance to continue to be robust as issuers continue taking advantage of the low interest rate environment to fund their mergers and acquisitions, stock repurchases, increased dividends and other general funding needs. Spreads could widen further if liquidity becomes a bigger problem than it is today.
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.