By Pax World Chief Investment Officer, Chris Brown

The many macro conditions that weighed heavily on investors in 2011 appear to have faded during the first quarter of 2012. Equity markets in general rallied significantly on favorable U.S. economic news, while most bond markets, with the exception of high-yield, showed muted returns. The S&P 500 Index[1] returned 12.59% and the Nasdaq Composite[2] gained 18.96% for the quarter. We believe money began to flow from fixed income to equities during the quarter as signs of an economic recovery became more apparent. The speed and magnitude of the recent equity gains have surprised many, including ourselves. We acknowledge the recent economic reports in the U.S have been encouraging in showing signs of a recovery. Job and wage growth have been improving and an increase in bank lending to consumers and small businesses has finally started to materialize.The economic environment has been positive for the markets, and recent stock market returns reflect this. We believe headwinds exist here and abroad that could cap near-term appreciation for the markets.

In Europe, the sovereign debt crisis appeared to be stabilizing as a result of the European Central Bank (ECB) announcement of the Long Term Recovery Operation (LTRO). Similar to our own version of the Troubled Asset Relief Program (TARP), LTRO provides banks with low cost money in the belief that it will create more lending. While we believe the recent ECB initiative, LTRO, is a step in the right direction, many challenges remain for the Eurozone. Spain now appears to be taking some of the negative headlines from Greece as their economy continues to struggle under heavy debt and austerity measures. As for Greece, the austerity measures being placed on their fragile economy will most likely stymie an economic recovery in the near term.

Based on recent economic reports, China appears to be exhibiting signs of weakness. The question remains: Will China have a soft or hard landing? Inflated real estate prices and the transition from a manufacturing to a consumer-driven economy have had a negative impact on  China’s growth.

Here in the U.S., higher gasoline prices could potentially be a drag on the economy, especially where the consumer is concerned. The Fed has indicated keeping interest rates low well into 2014. It should continue to be accommodative until stronger signs of employment appear and, ultimately, a recovery in housing prices is sustained. Against this backdrop, we believe the U.S. economy will continue to show signs of a recovery, albeit, at a bumpy pace. We anticipate limited upside to the equity and bond markets in the near-term and believe dividends will be an important part of a portfolio’s total return. We have been positioning the Funds to take advantage of current attractive dividend yields. In particular, we have been focusing on companies that are raising their dividends despite the weak economic environment. 

We feel several investment themes continue to hold promise. Due to the increasing population growth and demand for food in the emerging markets, agriculture remains attractive. Energy efficiency has become a dominant theme as more companies and the general population seek to reduce their energy costs.  Many industrial companies will benefit from demand for their products and services to satisfy the need to feed the world’s growing population and reduce energy consumption. While we feel there is limited upside for bonds in general, the spreads for high-yield bonds over treasuries remain high. Therefore, we believe high-yield debt continues to look attractive relative to other bond asset classes. Regardless of the investment environment, the portfolio management team continues to seek out attractively-valued companies with sustainable business models and forward thinking management teams.  


[1]The S&P 500 is the Standard & Poor’s composite index of 500 stocks, a widely recognized, unmanaged index of common stock prices. One cannot invest directly in an index

[2] The NASDAQ Composite Index is a broad based Index that includes over 3,000 securities. It is calculated under a market capitalization weighted methodology index.

The statements and opinions expressed are those of the author as of the date of this report. All information is historical and not indicative of future results and subject to change. This information is not a recommendation to buy or sell any security. Past performance does not guarantee future results.

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