Bond Market Holds its Own in Third Quarter Despite Housing Market, Consumer Spending Concerns
MADISON, Wis. -- Credit unions witnessed a sustained slowing of economic activity in the third quarter and there's still uncertainty on whether consumer spending will decrease given the flux within the housing market.
Those are some of the findings from MEMBERS Capital Advisors' Economic and Market Outlook for Third Quarter 2006. With nearly $14 billion in assets under management, MEMBERS Capital is the registered investment advisor of CUNA Mutual Group.
The key question for the economy going forward is how much impact the implosion in the housing market will have on consumer spending, according to MEMBERS Capital. Economists are divided, with some predicting that households will start saving more to offset the negative "wealth effect" of declining home values and others expecting income gains to support consumer activity.
There are also questions about how consumers will respond to interest rate resets on "exotic" mortgages and higher monthly payments, the report read. "The Fed's economic staff believes that the housing slowdown will trim a percentage point from economic growth for the next two quarters, which would indicate real (Gross Domestic Product) growth of 2-3%--a proverbial "soft landing."
Meanwhile, the bond market experienced a "great period" in the third quarter due in large part to "clarity" provided by the Federal Reserve's interest rate policy as inflation concerns eased in July and the Fed held rates constant at its August and September policy meetings. Those moves caused Treasury prices to rally with 10-year yields falling 51 basis points over the quarter, the report read. The slowed housing market did impact residential mortgage-backed securities, returning 3.78%, versus 3.64% for Treasuries.
Corporate bonds posted a strong quarter as investors continued to search for yield in a general low-yield environment.
"With the economy slowing enough for the Fed to perceive that inflation will be contained, investors' concerns shifted to prospects for lower corporate profits and increased event risk from continued activity in leveraged buyouts and private equity buyouts in the quarters ahead," MCA said.
For the remainder of the year, the firm believes that the below investment grade corporate fixed income market faces "continued headwind from the slowdown in economic growth and will lag the performance of investment grade corporates."
As for stocks, U.S. equities rose some 8% from their July lows to end the quarter at levels not seen since early in 2001, putting the S&P 500 up nearly 6% year-to-date, according to the report.
"We believe it is best to be prepared for slowing economic growth reflecting the housing turn [even if home prices don't actually decline], high energy prices [even if oil prices settle well below their recent peak], and more restrictive lending terms [even if interest rates decline somewhat]," MCA said. "In other words, we expect a return to more normal economic times."
Still, stocks could be heading into a more challenging environment, but MCA believes that "now is a time to avoid those lower quality areas that have led the market for some time, like small caps and deep value, and focus on more established companies that have historically been able to weather difficult times." These are generally larger companies classified in the growth area of the market that serve customers worldwide.
"Stocks of these companies should hold up best and could also lead the market higher when more economically favorable times return due to their more diverse product or service offerings and exposure to international markets, some of which are likely to lead the U.S. in economic recovery and in their rate of economic growth," MCA said. --firstname.lastname@example.org