Economic Backdrop

April stands the best chance thus far of qualifying for 2016’s least-eventful month. Market action proceeded in considerably calmer fashion than at any point during the first quarter, major central banks declined to expand headline-grabbing policies, and the general climb in oil prices continued. The weak-U.S. dollar trend appeared to stall for much of the month, only to resume as month-end approached.

The Bank of England (BOE) kept its bank rate steady on a unanimous vote, consistent with the standard script of recent announcements, but with the latest minutes betraying concern about the upcoming European Union (EU) referendum vote. European Central Bank policy held firm as the expanded asset purchases announced in March began, and the Bank of Japan left policy unchanged for the second consecutive meeting after introducing negative rates in late January and expanding asset purchases in December. The U.S. Federal Open Market Committee (FOMC) opted to maintain its current target rate, expressing reservations about recent domestic economic conditions but implying that a rate hike would remain possible at subsequent meetings.

U.K. manufacturing appeared set for a small contraction in April as new orders and output declined, according to a purchasing manager’s survey, despite an advance in overall industrial orders and output. Retail conditions deteriorated during April, with sales volumes at their lowest levels in more than four years following two months of falling retail sales figures. Price trends firmed in March, advancing by more than expected at both the consumer and producer output levels; a sharp increase in producer input prices had been anticipated as a result of higher energy prices. Claimant count joblessness increased in March for the first time since last summer, while average year-over-year earnings growth increased by less than expected in the three months ending February and the unemployment rate held at 5.1% for the same period. The overall economy grew by 0.4% during the first quarter, and 2.1% year over year, according to an early reading.

Eurozone services growth continued apace in April on rising new orders, and manufacturing improved modestly, although growth remained slow as expansion of new orders and production moderated. Consumer prices slid, reversing March’s advance, on weak inflation pressures in services pricing. Economic sentiment improved slightly during April, driven primarily by an increase in confidence regarding the industrial sector, along with services and construction. Consumer sentiment held firm, while confidence in the retail sector dropped and expectations for household spending continued to decline. Retail sales slid during March, more than offsetting recent gains, on fairly broad-based weakness. The unemployment rate edged lower in March, to 10.2%, on the largest decline in joblessness so far this year. A preliminary gross-domestic product report registered 0.6% first-quarter growth, and 1.6% from a year earlier.

U.S. manufacturing growth slowed in April, remaining just marginally in expansion territory, while services sector activity showed soft but improving growth. Industrial production declined in March, the sixth drop in seven months, and capacity utilization slid to the lowest level in over five years. Retail sales also slid in March, as auto sales dropped the most since February 2015. Consumer spending increased modestly in March, while consumer income advanced by considerably more. Consumer prices inched higher in March, and producer prices shrank for the first time since October 2015, primarily within the usually stable services sector. Jobless claims fell to their lowest levels in more than 40 years, achieving their 60th consecutive week below 300,000. First-quarter economic growth advanced by 0.5%, the lowest rate in two years. Growth was held back by subdued business investment, but propped up by consumer spending on services and housing investment.

Market Impact

Fixed-income market performance remained positive in April, as measured by the Barclays Global Aggregate Index. U.S. dollar-hedged indexes, which seek to reduce U.S. dollar-related volatility, generally underperformed comparable unhedged indexes in the face of headwinds created by the dollar’s relative weakness. U.S. high-yield bonds led, as measured by the BofA Merrill Lynch US High Yield Constrained Index, continuing a remarkable recovery. Emerging-market debt also delivered impressive performance, with local-currency denominated debt outpacing its foreign-currency-denominated (external) counterpart. Global sovereign securities and U.S. investment-grade corporate fixed income performed very well, and global non-government debt delivered notable performance. U.S. Treasury Inflation-Protected Securities, asset- and mortgage-backed securities were also positive, while U.S. Treasurys suffered a marginal decline.

Global equity markets, as reflected by the MSCI AC World Index (Net), advanced during April. Global sector performance was led by energy and materials, which have also delivered the best three-month performance alongside recovering commodity prices. Healthcare and financials delivered notable gains as well, and industrials continued a notable positive trend. Information technology suffered a steep, but isolated decline; utilities, the consumer sectors and telecommunications were all modestly negative. Performance was mostly positive at the country level, with a high concentration of Latin American and energy-exporting countries among the top ranks. Peru and Egypt led, followed by Brazil; Russia and Norway also performed very well, and Canada trailed at a close distance. Poland had the deepest losses, followed by Taiwan, the Philippines and Malaysia.

Index Data (April 2016)

• The MSCI AC World Index (Net), used to gauge global equity performance, advanced by 1.48%.
• The Barclays Global Aggregate Index, which represents global bond markets, rose by 1.33%.
• The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index”, increased in the month as a whole, moving from 13.95 to 15.70.
• WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $38.34 a barrel on the last day in March to $45.92 at the end of April.
• The U.S. dollar weakened against the world’s major currencies. The U.S. dollar ended April at $1.46 versus sterling, $1.15 against the euro, and at 107 yen.

SEI’s View

One of our bedrock macroeconomic assumptions has been that the world will avoid a generalised recession, managing to continue muddling through. We believe a synchronised global recession that drags most countries into negative gross domestic product territory remains a low-probability event, and if our forecast holds, the rally in risk assets should be able to build on itself. Certainly, there are good reasons to view the glass as half empty. Monetary policy appears to be losing effectiveness in Europe and Japan. Combined with an increasingly febrile political environment in the U.S. and other countries, as well as widespread sovereign and corporate over-indebtedness, it is easy to see why market strategists are still a cautious lot. But we think too much emphasis has been placed on the weaknesses of the global economy, while the brighter spots have been mostly ignored. Most major countries remain in an expansion phase despite sustaining a growth scare over the past year. The main areas of concern can be found in emerging markets, especially in commodity-producing countries.

On a sector basis, it’s obvious energy and materials have been the primary drag, but it’s a mistake to assume that a contraction in these industries will lead to a downturn in advanced, service-based economies. Even in light of recent oil-price strength, the spike in energy sector layoffs has been nearly offset by the improving trend in the construction trades as housing activity comes back to life. Total non-farm payrolls, meanwhile, appear to be growing near the upper end of the historical range.

The bottom line: We continue to believe that global economic growth will grind its way higher, led by the advanced and commodity-consuming emerging economies (including China and India). Although China’s debt is a concern, the bulk is owed by state-owned enterprises to quasi-state-owned banks. Only a small fraction is held by foreign investors. The central government’s debt ratio is rather low, and households are not highly leveraged either.

Another bedrock assumption of ours has been the conviction that central-bank monetary policy will remain highly expansionary on a global basis. Even in the U.S., where economic growth and inflation appear more entrenched than in most other countries, it is unlikely that interest rates will be pushed higher in an aggressive manner. A more interesting question is whether central banks have reached the end of their policy effectiveness. This issue has come to the forefront in 2016 as the BOJ, and then the ECB, implemented radical policy prescriptions only to see markets react negatively. In both Europe and Japan, government bond yields now are negative out to 7 and 10 years, respectively. If there is an overvalued asset in the world it is a negative-yielding government bond. And yet the yen and the euro have gained against the greenback on a year-over-year basis. This resiliency runs counter to our own expectation that a widening interest-rate differential between the U.S. and those two countries would keep the greenback strong. If the dollar’s weakness is sustained, it would have far-reaching consequences for global assets. It would, for example, be positive for commodities as well as emerging-market debt and equity.

It’s hard to make a fundamental case for this dramatic turn in the fortunes of emerging-market equities. Earnings per share (EPS) for the constituents of the MSCI Emerging Markets Index have collapsed over the last two years in U.S. dollar terms, a performance that correlates closely with the bear market in commodity prices. We need to see stronger global economic growth, improved trade flows and additional supply discipline from commodity producers. The sharp improvement in investor sentiment might be enough to keep the rally going in the short run, but it’s not enough for a sustained bull market.

At this point, we see better prospects for a durable earnings revival in the U.S. than elsewhere. The stalling of the dollar’s appreciation against other currencies in the past year suggests that U.S.–based multinational corporations and import-sensitive industries should see some relief from negative currency translations and declining import prices. Given the economic and political uncertainties, markets will remain difficult to navigate. We lean in a bullish direction, mainly because we are confident that the world economy will exhibit modest growth and that central banks around the world will do “whatever it takes” to coax their economies to grow and push inflation in an upward direction. Safety and stability still look expensive, as do government fixed-income securities. We like U.S. risk assets because the fundamentals seem better than most, although political dysfunction is becoming an increasing worry. Meanwhile, the sharp recovery in emerging-market debt and equity and high-yield securities underscores the fact that beaten-down areas can come roaring back with little advance warning. Under these circumstances, diversification seems a better strategy than concentrated positions as trends shift back and forth in almost random fashion.

Glossary of Financial Terms

• Asset-backed securities: Asset-backed securities are a type of securitised debt that are backed by loans, leases or credit card debt, but not mortgages. Securitised debt consists of a portfolio of assets, such as mortgages or bank loans, which have been grouped together and repackaged as individual securities.
• Bear market: A bear market refers to a market environment In which prices are generally falling (or are expected to do so) and investor confidence is low.
• Bullish: Bullish refers to a positive view on the markets whereby investors are anticipating economic and market growth.
• Fundamentals: Fundamentals refers to data that can be used to assess a country or company's financial health such as amount of debt, level of profitability, cash-flow, inventory size etc.
• High-yield debt: High-yield debt is rated below investment grade and is considered to be riskier.
• Macroeconomic: Macroeconomic refers to the broad economy of a country or region, or the global economy.
• Mortgage-backed securities: Mortgage-backed securities are made up of multiple mortgages packaged together into single securities. These can be comprised of commercial or residential mortgages. Agency means that the debt is guaranteed by a government-sponsored entity, while non-agency means that it is not.
• Treasury Inflation-Protected Securities: Treasury Inflation-Protected Securities are U.S. Treasury securities issued at a fixed rate of interest but with principal adjusted every six months based on changes in the consumer price index.

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