Everyday, Everyday I Have the Blues
By John Stoltzfus,
Chief Investment Strategist
Trend Analysis
Market Strategy Radar Screen Weekly June 13, 2016
In this article:
Trading Places – Revisited
Stock rally stalled as investors turned to bonds and gold
Stateside investors were reminded of the global markets’ interdependence last week as the concept of decoupling was once again debunked along the road to normalization.
A rally in stocks that began on May 19th took stocks to an intra-day level of 2,120.55 last Wednesday--within less than a half a percent of the S&P 500’s all-time high of 2130.82 reached last year--ran across a series of speed bumps in the shape of familiar concerns that ranged from:
- stateside and global growth worries to
- the direction and quality of monetary policy
- negative interest rates,
- rising and falling commodity prices,
- cross-regional currency relationships,
- Brexit risk in the UK and Europe
- uncertainty surrounding candidate platforms and the outcome of the US presidential election outcome
All of the above moved some investors to consider moving back to a “risk off” stance, which they did over the last two days of last week.
Stocks had led the other asset classes in a rally that began on May 19th and had carried the S&P 500 up some 3.88% through last week when stocks changed direction.
Asset classes traded places last week as stocks hit the series of speed bumps mentioned above causing them to take a detour from their recent path and to take a trim (if not a haircut), giving way to a rally in bonds which took the 10-year yield from 1.74% on Monday to 1.62% by Friday and bumped the price of gold 2.4% higher on the week.
A focal point of the worries dogging the markets of late has been that $10 trillion of debt worldwide is at negative yield.
Among major developed countries the 10-year yields of government debt in Germany, Switzerland and Japan last week were at ‑0.02%, ‑0.50% and ‑0.17% respectively.
As is well known, bond purchases initiated by monetary policy makers in Europe and Japan (in their respective efforts to combat deflation) have driven prices of a wide array of fixed income securities higher. At the same time the thirst for yield among investors, particularly in those countries experiencing negative yields, has grown greater-- pushing yields lower and compounding the problems created by abnormally low interest rates.
U.S. Treasury yields, which are comparatively rich to other developed country yields, have attracted foreign fund flows from foreign investors looking to quench their thirst for yield, pushing the U.S. 10-year Treasury’s yield down to 1.625% last Friday.
Investors stateside last week feared that Friday’s low yield on the 10-year Treasury might also be signaling further economic slowing or even a recession ahead.
In our opinion, the last concern is unfounded. While the latest non-farm payroll shocked and awed with its disappointing jobs number (+38,000 in May, compared to +160,000 expected), other economic data released in the days prior and since do not support the amount of negative projection that some investors have ascribed to the May non-farm payroll number.
Consider the Labor Department’s “JOLTS” data (Jobs Openings and Labor Turnover Survey), which last week was at its second highest level since the measure was created in 2000. We’d also point to initial jobless claims, which have been at record low levels for the last 66 weeks, positive housing data, consumer confidence, and wage growth (among others).
Beyond the economic data, which in our view continues broadly to signal that the current US expansion is sustainable (albeit at a moderate pace), we would also note that while a 1.6% yield on the U.S. 10-year note justifiably warrants investors’ attention, we’d posit that at previous points on the economic recovery and expansion time line when we’ve seen such low yields on the 10-year, this has not proved to be damaging to subsequent market performance.
Consider that the 10-year’s yield fell to around last Friday’s level as recently as February 11th of this year (1.66%) just before the S&P 500 began a rally that drove the broad market up nearly 15% through April 20th (see figure below).
Prior to that, we’d seen a yield of 1.6% on the 10-year Treasury on January 30th, 2015 after “another growth scare” (see Treasury Yield graph above). The S&P 500 rose 6.7% from January 30th through July 20th of that year.
Before that the 10-year yield was at 1.6% on May 1, 2013 around the time that Ben Bernanke, then Chairman of the Federal Reserve, announced that the Fed might consider “tapering” its monthly bond buying program. The S&P 500 rallied some 16.8% from May 1, 2013 through the end of that year.
The major indexes that had enjoyed the benefit of their latest rally that began on April 20th slipped lower in the latter part of last week with the S&P 500, the S&P 400 and the Russell 2000 respectively shedding 0.15%, 0.12% and 0.02% (see figure below).
Outside of the US, developed markets were more challenged with MSCI EAFE (developed markets ex-US and Canada) and the MSCI Emerging markets falling respectively 1.8%, and 0.94%. The Frontier markets fared better, easing lower just 0.10% on the week.
We believe what really matters to the market stateside in the weeks ahead will be signs of continued economic growth and the results and guidance that come out of Q2 earnings season (which will unofficially begin on July 11th when Alcoa reports).
The rally in the price of oil reflected in the energy sector and the effects of a lower dollar on revenues and earnings for multinationals in the S&P 500 could well serve to push stock prices higher over the summer.
For now we recommend that investors selectively overweight cyclicals versus defensive sectors, remain overweight US equities with a market cap agnostic view and avoid value traps as they seek cyclical companies that pay dividend income and offer prospects for capital appreciation.
Particularly noteworthy to globalist investors this week:
MSCI will announce its decision on June 14th on whether China’s yuan-denominated A-shares will be added to its indices.
If MSCI chooses to include these issues, they are expected to attract billions of dollars in inflows over the course of time into the Chinese bourses and give support to a market that’s been one of the world’s worst performers so far this year.
Since 2013 MSCI has formally insisted that improvements in China related to market accessibility would be needed for inclusion in the major emerging market indices.
Currently most investors outside China access Chinese companies via listings in Hong Kong, or as GDRs, ordinary shares and direct listings on foreign exchanges.
Barron’s reports this week that inclusion of the A- shares into the MSCI indices would be gradual and take place over several years.
MSCI Indexes would at first likely assign A-shares a 1.1% weighting in the MSCI Emerging Markets Index as reflected in ETF trackers.
Barron’s reported that Credit Suisse estimates that the weight would grow over time to around 18% of the benchmark once fully included.
For now, the decision and scope of the MSCI decision this week will be anticipated greatly by investors since reclassification of such a constituency is expected to trigger significant levels of purchases and sales to accommodate the change.
Other index sponsors have already begun the process including FTSE Russell and their partner the Vanguard Group, which began to add them at the end of last year to their respective emerging market indices and ETFs. Vanguard has said that it anticipates that around 6% of its emerging-market stock portfolio will include China A-shares by the end of this year.
Stateside, the Fed’s FOMC announces its decision on interest rates Wednesday at 2:00pm EDT.
Late Sunday night, futures indicated a 0.0% probability of a Fed hike this week.
Stay tuned.
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