Stocks Hit New Highs as Investors Say “Risk On!”

Global markets rallied last week, driving stock prices here in the U.S. to all-time record highs. Last week alone, the S&P 500 rose 1.5%. International equity markets performed even better, with the S&P Global Ex-U.S. BMI gaining 3.7% percent for the week.

Those gains were driven largely by investors’ mounting confidence that the U.K.’s Brexit vote to leave the European Union is unlikely to impede global economic growth significantly going forward.

Equity prices also rose on signs of economic strength in the U.S. that generated demand for riskier assets, including:

  • Stronger-than-expected job growth in June.
  • Fewer-than expected applications for unemployment benefits in early July.
  • Better-than-expected second-quarter earnings results from JP Morgan and Alcoa.

The equity market rally caused a sell-off among safe haven assets such as government bonds, which had been generating strong performance. Two weeks ago, for example, post-Brexit uncertainty pushed yields on 10-year and 30-year U.S. Treasury bonds to their lowest levels on record. Since then, investor demand for riskier assets has dampened interest in U.S. Treasuries, with two bond auctions during the past week showing the lowest demand in seven years.

Despite the relatively strong economic data in recent days, most investors still do not expect the Federal Reserve Board to raise short-term interest rates soon. Currently, traders are pricing in a less than 50 percent chance of a rate hike this year, even after last week’s better-than-forecast payrolls data.

GAIN: Active Asset Allocation

As global equity markets have stabilized and rallied, U.S. small-cap and mid-cap stocks have performed especially well. In addition, dividend-paying sectors such as real estate, financials and consumer stocks have been attractive to the large group of investors looking for attractive yields in the continuing low interest rate environment.

Despite pessimism from analysts, earnings season for the second quarter has started off strong (as noted above). That said, it is possible that volatility in various market sectors could rise as more earnings results and future earnings guidance are reported over the next few weeks, especially by the large bellwether companies in each sector.

In the fixed income markets, we believe corporate securities remain attractive. U.S. corporate balance sheets are generally healthy, and the large weight to the energy sector in the high-yield bond asset class has benefitted from a more stable oil price.

PROTECT: Risk Assist

Measures of anticipated future volatility continue to decline across multiple asset classes (including currencies, global equities and bonds). This suggests that investors are becoming increasingly comfortable with new “post-Brexit” valuations in various market segments. This is consistent with the one-time repricing scenario that we believed would be the case following an event like Brexit, rather than a contagion-inducing event that lead to a persistently volatile environment.

Due to the recent run-up in stock prices, the sensitivity levels that guide hedging decisions have been reset in some of the Risk Assist strategies. This approach, which we call ratcheting, is designed to help protect portfolio gains—in this case, the gains that have occurred following the brief sell-off following the Brexit vote.

SPEND: Real Spend

Inflation expectations remain low, with current CPI through May measuring 1% on an annualized basis. As global equity markets have stabilized and rallied, Real Spend’s exposure to dividend-paying stocks and U.S. mid-cap stocks have been positive contributors to performance thus far for the quarter. On the fixed income side, exposure to preferred stock has been beneficial, while exposure to municipal bonds has detracted from performance.  Additionally, Real Spend continues to emphasize dividend-paying stocks as a way to generate yield in the continuing low interest rate environment.

 

Categories: Market Notes
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