Quarterly market trends   |   Download PDF

Economic and market analysis from Putnam’s Asset Allocation, Fixed Income, and Global Equity teams.

  • Key takeaways

    U.S. equity markets generally advanced during the first quarter thanks to solid economic performance and low inflation.

    The strength of the U.S. dollar and the weakness of oil prices continued to play a role in market performance.

    Volatility remained somewhat elevated, stemming from questions about when the Fed might raise interest rates, concern over the efforts of a new government in Greece to renegotiate the terms of its financial aid from international institutions, and slowing economic activity in China and other emerging markets.

    In international markets, a combination of moderate economic improvement and new stimulus measures helped to lift performance, and results were even stronger in local currency terms.

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  • Key takeaways

    We think the economy will be strong enough to warrant a rate hike in coming months.

    Once the central bank begins to raise the federal funds rate, it will make every effort to do so in an orderly, well-communicated fashion so as to avoid major market disruption. While we recognize the theoretical risk to earnings, our empirical research shows that a strong dollar has not consistently undercut earnings in the past. We believe it may take more than a mighty dollar to make U.S. equities less attractive than other opportunities.

    With regard to high-yield issuers, outside of the energy sector, most appear to be in reasonably good financial shape. Corporations continue to take a conservative approach toward managing their assets and liabilities. We believe the default rate is likely to remain low overall.

    The general fiscal health and creditworthiness of the municipal bond market is solid, in our opinion.

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  • Key takeaways

    We like to remind investors that it's impossible to predict which asset class will lead — and which will lag — one year to the next. This chart shows the returns of nine asset classes arranged from highest return to lowest each year. Each asset class is a different color. So, for example, U.S. bonds are yellow, and international stocks are blue. You can see at a glance that the only pattern is that there is no pattern.

    The reason why so many financial advisors recommend diversification is precisely because there is no telling what the market is going to do from one year to the next. Diversification doesn't guarantee a profit, but by owning more asset classes, you have a better chance of owning the top-performing investments — or at least not owning too many of the worst-performing investments. Diversification can be obtained by assembling a number of different kinds of funds, but it can also be achieved within funds that have flexible mandates.

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  • Key takeaways

    One of the perennial concerns of investors is inflation, and for good reason. Inflation erodes the purchasing power of investment returns. Recently, inflation has been low by historical standards, but it's worth watching for this reason: Since 1913, there have been nearly 50 years in which inflation was between 1% and 4%.

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  • Key takeaways

    We believe the Fed is likely to begin raising rates sooner rather than later, possibly in September. In late March, fed funds futures, which are used by investors and traders to place bets on central-bank policy, showed that investors see only a 6% likelihood of a rate increase in June. Many investors believe the Fed will wait until September or even later before it begins raising rates. Consequently, there appears to be a considerable disconnect between what the market is forecasting and the Fed's own outlook, which could spark some volatility. In our view, however, once the central bank begins to raise the federal funds rate, it will make every effort to do so in an orderly, well-communicated fashion in an effort to avoid major market disruption.

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  • Key takeaways

    The previous slide showed the federal funds target rate, which is the target rate the Fed sets for overnight intrabank lending. This chart highlights some areas of potential opportunity, showing the difference in yield — also known as a "spread" — between one sector of the bond market and U.S. Treasuries. When spreads are high, it means investors are demanding additional compensation for taking on the risk associated with that sector of the market. (Treasuries are backed by the full faith and credit of the federal government.)

    The gray columns show the average spread for a variety of sectors during the 10 years before the financial crisis. Even with the recent narrowing, spreads today in some sectors are higher than they were before 2008. When spreads decrease, or "tighten," investors who already hold positions in spread sectors generally benefit, as the lower yields reflect higher prices. The difference in the yields is shown in the yellow columns and is measured in "basis points." One hundred basis points equals one percentage point, so the current high-yield spread of 546 is actually 5.46 percentage points above Treasury yields.

    The largest spreads are highlighted in the shaded box. Those include certain types of mortgage-backed securities that delivered poor performance when the housing market declined, but that today offer high yields in an environment of slow but steady recovery.

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  • Key takeaways

    Another area where we see select potential opportunity for fixed-income investors is outside the United States. This chart shows government bond yields and credit ratings from a number of countries around the world. Yields are generally low in the United States and developed markets.

    In many emerging markets, yields are higher because of uncertain economic conditions. Apart from Poland and a couple of other central European economies that are benefiting from an upswing in Germany, EM is struggling. Overall, we are focused on specialized opportunities in the emerging markets.

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  • Key takeaways

    This slide drills down a bit into the higher yields we saw earlier in high-yield bonds. Historically, the "spread" in the high-yield bond market has tended to follow the default rate. (The spread is the difference in yield between the sector and Treasuries.) That makes a certain amount of sense, because investors in high-yield bonds are being paid more to compensate for the fact that these bonds have lower credit ratings and are more likely to experience defaults — a situation in which the company that issues the bond fails to make payments of interest or principal. The default rate remains low by historical standards. However, spreads widened in 2014 amid expectations that defaults may increase. Investors who own high-yield bonds would benefit from a contraction in the spread, as the prices of the sector would rise as yields fell.

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  • Key takeaways

    During the 2008 credit crisis, the "spread" — or yield advantage — other segments of the municipal bond market offered over top-rated AAA securities increased dramatically, indicating that investors were demanding significantly more income for taking the risks they perceived in those parts of the market. While spreads have tightened significantly since then, in certain parts of the market they remain above normal, suggesting there may be compelling investment opportunities for active managers.

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  • Key takeaways

    Turning to another facet of the global markets, we've observed a significant change in economic growth rates since 2008. During the first half of the past decade, economic growth in a number of countries — both developed and developing — was relatively homogenous. But the financial crisis affected countries in very different ways. Countries like India, South Korea, and Taiwan that had no housing bubbles or banking sector challenges to speak of rebounded significantly after 2008. European countries, still struggling from the damage of the crisis, have experienced slower rates of economic growth than in a typical economic recovery, while U.S. growth is now accelerating. It remains to be seen whether the Japanese government's combination of loose monetary policy, fiscal austerity, and structural adjustment will result in lasting benefit to the Japanese economy. This disparity means that global investing is a potential way to tap into a wider range of opportunities.

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  • Key takeaways

    On a historical price-to-earnings basis, the European stock market does not appear to be especially cheap, while Japanese stocks, on the other hand, appear more reasonably valued. However, in looking at forward valuations, we see more valuation support in Europe. If, as expected, the economic recovery in Europe gains traction over the next several years, corporate revenue growth should improve, and we anticipate margins will surprise positively given the cost cutting that company managements have undertaken during the recent period of Europe's financial and economic stress. On a forward basis, European stock multiples thus look attractive relative to stock multiples in other markets.

    With the current price-to-earnings ratio (P/E) of U.S. stocks at approximately 16x, some market observers think that stocks in general have become too expensive. The P/E has expanded in recent years and is now slightly above average historical levels. However, compared with bond yields, it is hard to argue that the stock market is anything but cheap.

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  • Key takeaways

    In the United States, since the recession, companies have become more financially healthy, paring down their debt and expenses and growing earnings. U.S. companies also have begun to show more top-line, revenue-related profit growth. One way to measure that change is in the number of companies that have decided to initiate or increase the dividend they pay to stockholders.

    This slide shows that since 2010, the number of S&P 500 companies that have decided to increase their dividend payments to shareholders has been steadily on the rise. Meanwhile, the number of companies ceasing payment has declined. Paying or raising dividends is one sign of positive corporate health and typically means that a company has excess capital that it can afford to distribute to shareholders.

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