With the first-quarter 2011 earnings season coming to a close, second-quarter outlooks from market watchers at Artio Global Management, BlackRock and LPL Financial show them expecting a slower Q2 as demand for equities slows.
Companies in Q2 2011 will face headwinds from typically slower seasonal demand as well as lingering effects from the earthquake and tsunami in Japan, they say. Osama Bin Laden’s killing also may contribute to market uncertainty in the second quarter along with continued unrest in the Middle East and North Africa and rising oil and commodity prices.
And with the scheduled June 30 end to the U.S. Treasury’s QE2 bond-buying program, investors can expect to see a rise in interest rates, says J.P. Morgan Asset Management’s chief strategist. Standard & Poor’s equity researchers, however, offer a contrarian view, saying that the Fed’s absence from the bond market will lead to a decline in yields.
Sam Dedio (left), head of U.S. equities at Artio Global Management and a portfolio manager of four funds including the US Multicap Fund (JMLAX) and the US Smallcap Fund (JSCAX), saidTuesday that the second quarter of any given year is usually marked by less demand for stocks. Investors in the first quarter have already done their buying for 401(k) plans, Dedio explained, and the second quarter includes tax day in April.
Until the U.S. unemployment picture shows more improvement, “the potential for the consumer to snap back is diminished,” Dedio noted. As a result, he is guarded on the Consumer Discretionary sector, though he is bullish on the Industrial sector, which he believes will ultimately contribute to U.S. job growth.
“When I look at other sectors, like Industrials, I really think that this is a capital spending-led recovery,” Dedio said. “If I had to pick a sector to be Overweight on, it would be the Industrials sector. Emerging market demand is really strong in the economies of South America, Asia and China, and a lot of the Industrial companies are benefiting from what’s going on there.”
As for geopolitical risks, Dedio expects to see some after-effects of the Japanese disaster work their way into Q2 earnings. For example, Coach, one of the companies he holds in the Multicap Fund, said it expected to see a drop in earnings of 2 cents to 3 cents a share due to events in Japan. But he believes that bin Laden’s demise is less of a market risk.
“I think the bin Laden killing will have less of an impact than Japan,” Dedio said. “But there’s a risk premium that gets injected back into the market because people will be more fearful.”
Burt White, chief investment officer with LPL Financial, pointed out that the Japanese disaster hit late in the first quarter, which means that its market effects will be felt most strongly in Q2 2011.
“Japan is going to be a second-quarter issue,” White said in an April 21 interview. “The market was worried about whether Japan would have any first-quarter
earnings, but we’ve heard very little from it. You had Texas Instruments and a couple of tech companies talk about supply disruptions, but that’s a second-quarter issue.”
BlackRock’s Q2 asset allocation overview also points to uncertainties arising from Japan along with other regions of the global economy.
“Expanding unrest in the Middle East and North Africa, rising oil and commodity prices, and the Japanese earthquake crisis have increased downside risks to the economy and to risk assets. While we acknowledge volatility will be elevated in the short term, we still believe that equities have longer-term upside and that opportunities exist in some fixed income credit spread sectors,” write Bob Doll, BlackRock’s chief strategist for fundamental equities, and Peter Fisher, global head of fixed income
They advise investors to closely manage equity risk and to be even more selective in fixed income.
As for the Federal Reserve’s quantitative easing program, J.P. Morgan Asset Management Chief Strategist David Kelly (left) said April 21 that the fixed-income markets are likely to see interest rates trend higher as the U.S. economy grows stronger. The Fed is still on track to end QE2 on June 30, and QE3 will not become a reality, according to Kelly. That, he predicts, will take demand out of the Treasury market, and when demand drops, prices fall and yields rise correspondingly, thus lifting interest rates.
“Just through purchases of Treasuries, never mind recycling mortgage-backed securities, the Fed has been buying about $75 billion per month. When they leave, that is going to have an impact on the Treasury market,” Kelly said. “In addition, a lot of individual investors have been putting money into bond funds. I think that will begin to dry up a bit. Between plenty of supply and a decline in the demand for Treasuries, I expect long-term interest rates to go back up. We’re at about 3.4% now, and by the end of the year we could easily be at 4% for 10-year Treasury bonds.”
In a Trends & Ideas comment published April 25 for Standard & Poor’s MarketScope Advisor, equity analyst Michael Souers considers what an end to QE2 would mean for various asset classes and makes some mutual fund picks—and his conclusion is contrarian.
“Risky assets such as stocks and commodities may sell off with money flowing into the classic ‘risk-off’ trade of government bonds. While it may be a contrarian or counterintuitive view to think that the absence of the Fed from the bond market will lead to yields declining, that is exactly what happened when QE1 ended,” Souers writes.
Believing an end to QE2 might boost demand for Treasury bonds, Souers says the following S&P four- or five-star-rated mutual funds could benefit:
American Century Government Bond Fund (CPTNX)
Dreyfus Bond Market Index Fund (DBIRX)
Vanguard Short-Term Federal Fund (VSGBX)
Read Aspen Partners' Ben Warwick on the end of QE2 and its potential effects on the U.S. dollar at AdvisorOne.
For more information on Q1 2011 earnings read AdvisorOne’s 2011 Q1 Earnings Calendar for the Financial Sector.