Quarterly market trends   |   Download PDF

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

  • Key takeaways

    While U.S. equities closed out 2014 with yet another annual gain, the fourth quarter was anything but calm for investors. The dominant theme was energy — plummeting oil prices, severe weakness in energy stocks that are closely tied to the price of oil, and the resurgence of volatility in response. Non-U.S. markets faced more troubling macroeconomic conditions, and generally declined in U.S.-dollar terms. Emerging markets continued to struggle. These economies have taken on dollar-denominated debt, and now face challenges with the strength of the dollar and rising short-term interest rates. Many emerging markets will be funding themselves at higher short-term rates and servicing their debt with more expensive dollars.

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  • Key takeaways

    Beyond the struggling energy sector, our outlook for U.S. corporations is solid, although 2015 may not be as strong as 2014. We believe corporations should be able to generate high-single-digit growth in the year ahead. A number of factors could boost equity performance. For example, U.S. consumers have benefited from continued low interest rates, a healing housing market, and improving employment along with moderate wage growth. A key challenge for equity investors in 2015 will be navigating a likely hike in short-term interest rates by the Fed.

    We see a range of opportunities in international markets. Increased monetary stimulus, weaker currencies, lower oil prices, and the completion of asset-quality review in Europe of financial institutions should all become tailwinds for non-U.S. stock performance. Within investment-grade fixed income, we expect U.S. economic growth to maintain its recent strength. Domestic corporate fundamentals, with the exception of the energy sector, remain strong, and therefore high-yield issuers appear to be in relatively good shape.

    We continue to have a negative view of commodities.

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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

    At several periods since the 2008 credit crisis, markets experienced historic bouts of volatility. Because of this trend, diversification is even more important today. From January 2003 to December 2007 (the black line), stock market volatility (as measured by the S&P 500) was fairly low. Daily market moves of more than 2% in either direction were rare. But between January 2009 and December 2013 (the red line), market moves of +/-2% were much more common; fluctuations of 4% or more were not infrequent.

    Why has it been more volatile? A number of reasons: A housing bubble burst here and in Europe, we went through a recession, and Europe's economy continues to struggle to recover. And many countries still have a lot of debt as a result of fighting off the recession. It is important to note that experience shows that this relative calm does not last forever

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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, particularly returns that are fixed, like U.S. Treasuries. 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

    Interest rates began to rise in the spring of 2013, as positive economic data prompted investors to begin debating when the U.S. Federal Reserve would begin scaling back its stimulative bond-buying program. The Fed ended its bond-buying program in October 2014. However lackluster economic data, geopolitical crises in Ukraine and Iraq, and emerging-market currency concerns caused investors to assume a more risk-averse posture, driving down yields on U.S. Treasuries and keeping interest rates low. When rates have risen in the past, they've tended to rise sharply. Since bond prices generally move in the opposite direction of interest rates, it leads to significant losses for investors who bank on a further decline of interest rates.

    With Fed bond-buying over, we expect to see stronger growth from developed markets, while emerging markets in aggregate may experience further currency and capital market weakness. The Fed also has indicated that it plans to raise its federal funds target rate in mid-2015. Moreover, we expect credit, liquidity, and prepayment risks will continue to be rewarded by the market in the months ahead, while interest-rate risk remains unattractive due to its asymmetric risk profile.

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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 568 is actually 5.68 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 a number of yields from government bonds around the world. The size of the circle corresponds to the size of that country's yield. Yields in the United States remain historically low, but other countries offer attractive income opportunities. Some European, Asian, and South American countries offer higher yields than U.S. Treasuries. Of course, a number of these countries are facing fiscal challenges and may represent increased risks.

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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 those faster-growing economies.

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  • Key takeaways

    We're going to move to stocks now and highlight an important trend and potential opportunity for investors, and that's valuation. In a nutshell, all the investor concern in recent years has prevented the market from fully reflecting the earnings of companies around the world. This chart demonstrates that by showing price/earnings ratios, or P/E. The P/E ratio measures the relationship between the price of companies' stock and the earnings they generate. Lower ratios in a number of equity markets today mean that investors have to pay relatively little to invest in a company relative to the earnings they generate. This may be a sign for investors who believe that earnings will continue to grow, and that prices will follow.

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  • Key takeaways

    That valuation story is also playing out here 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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