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US Markets, a Different Kind of Triple Threat

The Rockettes
Laura Cavanaugh | Getty Images
The Rockettes

Living in New York City and working just minutes from Broadway, one often hears about the rare and wonderful "triple threat" – someone who excels in three areas on stage: acting, dancing and singing.

The U.S. became a financial markets' triple threat in the first quarter, with U.S. equities, U.S. government bond yields and the U.S. dollar all rising in tandem—something that rarely occurs for any sustained period. Indeed, looking back to the early 1970s when the dollar started floating, a U.S. triple threat (positive returns for the S&P 500 and the trade-weighted dollar, along with rising U.S. 10-year bond yields) only occurred 15 percent of the time. The last time we saw these U.S. assets kicking it together in a Rockettes-like lockstep for a quarter or longer was 2005.

There are at least three takeaways from this first-quarter financial anomaly.

1. The U.S. economy is leading the global pack—despite fiscal headwinds. U.S. economic momentum in early 2013 positively surprised, and is greater than economic growth occurring overseas. This, in turn, is leading capital to the U.S. and supporting local assets. That same relative view of the world is also boosting U.S. yields, as investors price in tighter U.S. monetary policy over time. Consider equities: in the first quarter, global equity mutual funds and ETFs saw some $107 billion in total inflows, the strongest quarterly flow since 2000 and with capital biased towards the U.S. (EPFR Global data, including March 2013 estimates).

(Read More: Fed Keeps Easing, Not Worried About Stock Bubble)

2. The American investor remains cautious: we are a long way from needing to worry about irrational exuberance. Despite the first-quarter move towards stocks, we are not seeing similar capital shifts into other assets that would reflect a stronger cyclical view. Commodities, for instance, which should at least partially reflect demand expectations, fell more than 1 percent in the first quarter, using the Dow Jones-UBS index.

In addition, the type of equities that performed best in the first quarter—defensive sectors such as consumer staples, health care and utilities— suggested investors were not aggressively betting on economic strength but rather just wanted to get a little cash back into the market, seeking yield as much as capital appreciation from stable large-cap firms.

3. The U.S. is not the only country with an implicit weak currency policy. Indeed, other countries beat the U.S. in the "race to debase" in the first quarter. The Japanese yen lost nearly 8 percent against the dollar in the first three months of 2013, as the Bank of Japan pledged to do 'whatever it takes' to stamp out deflation. The British pound, meanwhile, fell 6.5 percent versus the dollar, in part on expectations that the Bank of England would tolerate higher inflation for longer as a price to pay for a stronger economy. The euro underperformed the dollar by nearly 3 percent, in part as non-existent growth and renewed peripheral stress (Cyprus and Italy) led investors to expect a greater easing bias from the European Central Bank.

(Read More: Cyprus Finance Minister Quits; Controls Eased)

Looking ahead, we believe the U.S. triple threat might stay on center-stage a while longer. U.S. equity valuations have clearly risen but remain reasonable, while share buybacks are reducing supply. Assuming growth trends are in line or better than Q2 consensus estimates (GDP growth moderating in the U.S. and improving overseas) and capital continues to toddle back into the market, U.S. equities should see another positive quarter.

Meanwhile, 10-year bond yields remain so low by historical standards that another quarter of modest increases would not surprise anyone, especially should the U.S. macro backdrop continue to gradually brighten. The dollar is more of a wild card—improving global sentiment in the coming months, alongside some relatively attractive valuations overseas, could help lead U.S. investors to increase foreign exposure, potentially selling dollars along the way.

Aggressive central bank easing in Japan and Europe (the euro, yen and sterling represent just over a quarter of the Federal Reserve's trade-weighted dollar basket) may not lead to enough FX weakness to make up for potential gains in a few key emerging-market currencies (the Chinese renminbi and Mexican peso alone represent 31 percent of the dollar basket).

Triple threat or not, U.S. financial markets seem well positioned to play at least a leading role on the global stage in the quarter ahead. On a tactical basis, we are advising our clients to keep a maximum underweight to traditional government bonds and an overweight to equities.

Rebecca Patterson is the CIO of Bessemer Trust and has overall responsibility for investments, including asset allocation, strategic portfolio direction, and research. She is chairman of the Investment Policy and Strategy Committee and a member of the Management Committee. Patterson is also a CNBC contributor.

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