Not Wailing, But Shrugging

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By Brad Tank, Chief Investment Officer - Fixed Income

Bottom-up is back as the markets take big macro data in stride.

When one of the most-watched macroeconomic data releases misses expectations by as much as the U.S. jobs report did on June 3, you might expect some wailing and teeth-gnashing from the markets.

The U.S. added 38,000 new jobs in May, a full 120,000 fewer than expected. Another 59,000 jobs were revised out of the March and April readings, too. Federal Reserve chair Janet Yellen described those data as "concerning" - a stark contrast with a fortnight ago, when she was talking up the prospect of a summer rate hike.

Precisely because they tend to sway with the wind of the prevailing data, we believe investors should focus more on interest rate forward markets than FOMC members' pronouncements.

But in this case, the markets have proven almost as fickle. A month ago the market-implied probability of a rate hike at this week's FOMC meeting was 4%; at the end of May it peaked at 34%; now it's below 2% again.

Taking Macro News in Stride

And yet outside of interest rates, the markets have been shrugging, not wailing. The S&P 500 is a whisker from its all-time high. The VIX has trundled along at 13%-16%. Emerging markets debt and U.S. high yield are up around 10% year-to-date, which is pretty remarkable given the fears of the first quarter and the potential of that big jobs miss to blow the recovery off course. Equally remarkable, markets were just as sanguine about the surprisingly hawkish Fed minutes that came out in May, suggesting that they were reassured by the central bank's confidence in the economy.

After getting used to risk markets responding positively to bad macro news and negatively to good macro news, it now appears we may need to get used to them ignoring the macro stuff altogether.

Bottom-Up Investing and Lower Stock Correlations

This is something I hinted at in my last contribution to CIO Perspectives, which described a renewed focus on company fundamentals now there are no big currency themes for investors to obsess over. It's as though investors have at last found the thinking space to sort the micro issues out.

Take the recent rally in U.S. equities. Small- and mid-cap have joined in this time around in a way they didn't during the rally of last autumn, when large-cap growth dominated. Correlation between stocks has been dropping.

We see it in U.S. high yield, as well. What has really changed since the beginning of the year? The difference between oil at $50 per barrel and $30 per barrel is negligible when all of your capex was done at $100 per barrel and, sure enough, we have seen $26 billion worth of bonds default already this year, well ahead of the $18 billion for the whole of 2015. But the key thing is that, as we anticipated, this distress hasn't spread to other sectors. In most cases, these defaults have been priced in well ahead of the event, too: With the turmoil of the first quarter behind us, we are left with a very orderly, bottom-up focused market.

Jobs Data: A Big Miss or a Sign of Ongoing Recovery?

Of course, markets are not really ignoring the macro picture. It's more about recognizing the steady state of modest recovery that the global economy is in. The big jobs miss could just be the odd soft data point that occasionally comes up when growth is closer to 2% than 3% - one quarter it will be manufacturing numbers, the next it will be employment, but the overall trajectory remains clear. It may even reflect the tight hiring conditions of an economy close to full employment - evidenced by healthy wage growth, as well as last week's Job Openings and Labor Turnover Survey (JOLTS), which showed new vacancies rising even as hiring slowed down.

For sure, there are lots of exogenous storms that could upset this calm, not least the vote on the U.K.'s membership in the European Union in a couple of weeks' time and the U.S. presidential election in the autumn. But the macroeconomic picture is much clearer now than it was six months ago: growth modest but steady; inflation ticking up but a long way from frightening the central bank horses; not too hot, not too cold. Against this background, we believe markets can retain their calm, and active managers can get back to the fundamental business of sorting the wheat from the chaff in their markets.

Statistics on the Current State of the Market - as of June 10, 2016

Market Index WTD MTD YTD
S&P 500 Index -0.1% 0.0% 3.6%
Russell 1000 Index -0.2% 0.0% 3.5%
Russell 1000 Growth Index -0.4% -0.1% 1.7%
Russell 1000 Value Index 0.0% 0.1% 5.5%
Russell 2000 Index 0.0% 0.8% 3.1%
MSCI World Index -0.8% -0.5% 1.6%
MSCI EAFE Index -1.7% -1.5% -2.2%
MSCI Emerging Markets Index 1.0% 2.2% 4.6%
STOXX Europe 600 -2.7% -2.6% -3.4%
FTSE 100 Index -1.4% -1.6% 0.2%
TOPIX -0.5% -3.6% -13.1%
CSI 300 Index -0.6% 0.0% -14.8%
Cash & Fixed Income
Citigroup 2-Year Treasury Index 0.1% 0.3% 1.0%
Citigroup 10-Year Treasury Index 0.6% 1.8% 6.4%
Barclays Municipal Bond Index 0.5% 0.7% 3.4%
Barclays US Aggregate Index 0.4% 1.0% 4.5%
Barclays Global Aggregate Index 0.3% 2.0% 8.0%
S&P/LSTA U.S. Leveraged Loan 100 Index 0.3% 0.3% 5.8%
BofA Merrill Lynch U.S. High Yield Index 0.9% 0.9% 9.1%
BofA Merrill Lynch Global High Yield Index 0.7% 1.2% 9.0%
JP Morgan EMBI Global Diversified Index 0.7% 1.7% 8.5%
JP Morgan GBI-EM Global Diversified Index 1.6% 3.3% 11.2%
U.S. Dollar per British Pounds -1.3% -1.5% -2.8%
U.S. Dollar per Euro -0.3% 1.5% 4.0%
U.S. Dollar per Japanese Yen -0.1% 3.7% 12.5%
Real & Alternative Assets
Alerian MLP Index -0.2% 2.4% 11.8%
FTSE EPRA/NAREIT North America Index 0.3% 1.3% 7.1%
FTSE EPRA/NAREIT Global Index 0.1% 1.4% 6.2%
Bloomberg Commodity Index 2.1% 4.2% 13.4%
Gold (NYM $/ozt) Continuous Future 2.7% 4.8% 20.3%
Crude Oil (NYM $/bbl) Continuous Future 0.9% -0.1% 32.5%

Source: FactSet, Neuberger Berman LLC.

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