“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way — in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”

Charles Dickens, “A Tale of Two Cities”


The dichotomy between this week’s economic and capital markets indicators was a “tale of two cities.” The economic releases portrayed the best of times while the capital markets were reacting as if it were the worst of times. Quarterly corporate earnings reports through this week generated 77 percent positive surprises and only 15 percent negative surprises. U.S. employment surged in April; purchasing managers indices signaled near boom level expansion. Yet investors shed risky assets in fear of Greek sovereign debt risk contagion. Uncertainties in the UK election, financial regulation in the United States, and the BP oil spill added to investor skittishness. As if that were not enough, a yet-to-be-explained trading system glitch appeared to shake any remaining confidence out of the stock markets. Equities fell across the globe. Government bonds rallied, but corporate spreads widened as investors demanded more yield to assume corporate risks; spreads for BBB bonds, which had dropped below 175 bp in April, surged to over 204 bp this week. Commodities and oil prices fell; oil dropped over $10 to just over $75 per barrel. Bloomberg’s Financial Condition Index fell below zero for the first time since February.


During times like these it is natural to ask, “Which is this, the best of times or worst of times?” The answer is complicated; it is both. The global economy is recovering from the quake of the Great Recession, but recovery has been uneven and has experienced some aftershocks. Some of those aftershocks are related to the original quake; others are independent. Had we not experienced the Great Recession, the aftershocks would not have been so scary. Had we not seen how a subprime crisis in the United States infected the global financial system, we might not have been so worried about the sovereign debt crisis in Greece.

Prior to the past several weeks, the capital markets had incorporated a great deal of the recovery into their prices. Corporate spreads for both investment grade and high yield bonds had narrowed to an optimistic range; equity markets over the last year incorporated strong earnings reports and hope for an expanded recovery. When your stomach is full and you hit a bump in the road, you feel it. The reaction is natural, not unexpected, and it is likely to continue for a bit until we show that we can work through the problems.

What should investors do? It is natural to think about getting out of the market; the obvious time to do that is before the quake hits. If you did so, you may not need my advice. If not, a good question to ask yourself is whether you will be able to get back in at lower prices to benefit from exiting the equity market. In 2008 the equity markets declined by double digit rates; if you got out of the markets, were you able to get back in at lower rates to capture the benefit of the rebound in 2009?

A more productive use of the aftershock is to use it to determine if your risk exposure is correct. What is your mix of risk free and risk assets? You don’t necessarily want to optimize your risk exposure to a maximum loss scenario, but loss events are good tests of whether the risk exposures that you have selected are correct. It may be time to consider re-balancing.

In the spirit of full disclosure and on a personal note, I am writing these comments after our youngest daughter and I were victorious in a game of father/daughter Pong during the celebratory graduation weekend.

Economic releases

The European Central Bank met and, as expected, maintained its rate unchanged at 1.00 percent. Many expect that quantitative easing will take place in the face of the sovereign debt crisis emanating from Greece. Factory orders in Germany increased 5.0 percent and industrial production increased 4.0 percent in March.

U.S. personal income and spending rose +0.3 percent and +0.6 percent, respectively, in March; factory orders increased 1.3 percent. In the first quarter productivity increased 1.3 percent while unit labor costs declined -1.6 percent.

The U.S. employment report was a welcome bit of good news, especially for those that got the 290,000 new jobs (non-farm payrolls in red below) in April; even manufacturing (blue) added 44,000 to its payrolls. In addition March’s NFPs were revised up 58,000 to 230,000. These jobs are not just government workers; private payrolls made up 231,000 of the additional jobs. The four-week average of initial jobless claims (green) has dropped to 458,500; the most recent week dropped to 444,000. So many people have sought to come back into the labor force that the unemployment rate increased two ticks to 9.9 percent. Average hourly earnings were flat, but the weekly hours worked ticked up to 34.1.


Apr 30 cs Home price indes

Purchasing managers expressed even greater optimism this month. U.S. manufacturing (blue) reached a new high over 60. U.S. services (red), European manufacturing (green), and European services (purple) were well above the 50 demarcation between expansion and contraction. Not shown were the UK’s PMIs of 58.2 and 55.3 for manufacturing and services.


Apr 30 cs Home price indes

Sources: Bloomberg LP


Equities markets

The equity markets ignored the positive earnings reports as investors bailed out of stocks across the globe. European stocks experienced the biggest weekly drop in 18 months. Declines over the past two weeks have erased positive YTD returns across the globe.


Apr 30 cs Home price indes


Bond markets

Government bond yields fell as investors across the globe reached for a safe harbor.


Apr 30 cs Home price indes



The U.S. dollar rallied against the euro, pound and looney again this week.


Apr 30 cs Home price indes

Economic sectors

Materials and the small cap value sectors fared the worst this week. Consumer staples and large cap value sectors lost the least. No sector escaped this week’s market downdraft.


Apr 30 cs Home price indes

Source: Bloomberg LP