U.S. stocks continued their impressive run in April, only pausing temporarily when Standard & Poor’s downgraded the outlook on U.S. debt and raised the possibility that the U.S. government could lose its AAA rating.  However, investors focused their attention on strong corporate earnings and the Fed’s commitment to keep interest rates low for an “extended period.” 

302 companies in the S&P 500 have reported earnings so far, and about76% of those companies topped estimates.  Overall, first quarter profits and sales grew 20% and 10%, respectively.  Materials, Energy, Industrials, and Technology reported the most profit growth.

Meanwhile, the Federal Reserve announced that they plan to complete its $600 billion of Treasury security purchases through June and, even then, will maintain accommodative monetary policy to keep borrowing costs low.  The Fed did, however, acknowledge increasing inflation risks and that further easing is unlikely.  Traders peg the odds that the Fed will leave interest rates unchanged through its December meeting at 82%, a big increase from 59% a month ago.

Large Cap stocks narrowly beat out Mid and Small Cap stocks in April, although the S&P 400 Mid Cap Index and S&P 600 Small Cap Index reached new all-time highs.  The S&P 500 remains almost 15% below its all-time high set in October 2007.

Healthcare, generally viewed as a defensive sector, was the top performing S&P 500 sector in April with a 6.52%. Healthcare stocks have long been priced for low expectations and offer a good risk-versus-reward opportunity. The group should benefit from long-term trends such as an aging population, significant international exposure, and financial flexibility to grow and return value to shareholders.

Developed International markets (as measured by the MSCI EAFE Index) were the top performing asset class with a 6.02% gain. The MSCI EAFE Small Cap Index advanced 5.27%.  Gains in the MSCI EAFE were driven by Germany (6.72%), France (3.33%) and the United Kingdom (2.99%).

Emerging markets advanced 3.12% in April, led by strong returns in South Korea (4.07%) and Taiwan (3.74%), which both reported record exports in March.  Exports accounted for 52% of Korea’s GDP in 2010 and 67% of Taiwan’s GDP in 2010.

Corporate bonds gained the most in eight months in light of strong earnings growth and benchmark Treasury yields declining from a one-year high – the 10-year Treasury fell to 3.36% from its February high of 3.77%. High-yield (junk) bonds again posted solid monthly returns, evidence that bond investors are stretching for yield with the Fed holding interest rates near zero.

The best performing fixed income sector was TIPS, which is a result of rising inflation expectations from the bond market.  The 10-year breakeven rate – the difference between a nominal 10-year Treasury yield and the 10-year TIPS yield – rose from 2.49% to 2.57% during the month, which means the bond market expects inflation to average 2.57% during the next ten years.

First quarter GDP showed that growth slowed from 1.8% from the 3.1% in the previous quarter, while personal consumption (70% U.S. GDP) fell to 2.7% from 4.0%.  Nevertheless, recent economic data continues to point to growth.  The Index of Leading Economic Indicators increased for a ninth straight month and manufacturing surveys point to continued growth.  Additionally, industrial production rose 0.8% and capacity utilization rose.

Peter Lazaroff, Investment Analyst

www.acrinv.com