Market Update: Tuesday, February 9, 2016

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  • Indexes pare losses in late-day rally. Equities finished notably lower on Monday, though well off intraday lows thanks to a rebound in energy stocks, which rose despite another 2.8% slide in WTI crude oil. As investors dumped equities in favor of safe havens like gold and Treasuries (yields on the 10-year fell another 0.09% to 1.76%), the financial sector bore the brunt of the selling pressure, although materials and consumer discretionary stocks also tumbled. Dow -177.92 at 16026.91, Nasdaq -79.39 at 4283.75, S&P 500 -26.61 (-1.4%) at 1853.37
  • Equities’ freefall continues. U.S. markets are adding to Monday’s losses on the heels of sharp declines overseas, led by financials. In Asian trading overnight, investors’ flight to safety continued to push the yen higher and drove yields on Japanese government debt into negative territory for the first time ever. As a result, bank stocks were pummeled and dragged the Nikkei Index down 5.4%, its largest single-day decline in three years. Disappointing economic data out of Germany are also adding to Europe’s woes, after reporting a decline in both imports and exports. Meanwhile, COMEX gold is little changed, oil turned lower again after a slight rebound overnight, and Treasuries are moving higher.

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  • 10-year Treasury yield near 1-year low. The 10-year Treasury yield fell to 1.75% yesterday, confirming a break below the April 2015 lows of 1.85% and approaching the lows of January 2015 at 1.65%. Short-term yield also fell in response to declining rate hike expectations, though not as much as the 10-year, leading the yield curve to flatten slightly for the week. The last time the 10-year yield hit this level, ultra-low rates in Germany and other foreign countries helped drag U.S. yields lower, before growth expectations pushed yields higher.
  • Bank credit quality fears return. Bank credit quality has taken the baton among investor fears and is showing up in credit default swap (CDS) spreads, with the average spread of the top six U.S. banks moving 0.11% higher last week to 1.0%, up from 0.72% at the end of 2015. Although a notable move, the average remains well below the 3.4% peak of late 2011 and 4.3% peak of 2008. More substantial moves are occurring among a limited number of European banks.
  • Look out for falling angels. Investment-grade corporate bonds have not been immune to energy weakness and the average yield spread of investment-grade (IG) rated corporate bonds has widened to 2.0%, not far from the mid-2011 peak of 2.5%. Excluding energy, the average IG yield spread is 1.6%, but still above the long-term average of 1.3%. In this week’s Bond Market Perspectives, due out later today, we look at the potential implications of downgrades of IG energy bonds into the high-yield bond market.
  • High-yield spreads widen, back above 8%. High yield spreads widened again last week, as a midweek oil rally faded and Treasury yields fell. We continue to believe that market default expectations are too pessimistic, and that a current spread of more than 8% to Treasuries, and a yield of 9.5% for the Barclays High Yield Index, may be attractive for longer-term investors. However, volatility is likely to continue in the near term as high-yield bond prices closed below the mid-January lows yesterday, suggesting the market continues to search for a bottom.
  • Municipal bonds follow Treasury strength. Municipal bonds followed Treasuries higher last week, although they failed to match the magnitude of the Treasury gains. Both 10- and 30-year municipal-to-Treasury yield ratios have increased since the start of 2016, which isn’t surprising given that municipal bonds generally trail during periods of Treasury strength like the one witnessed recently. An above-average $9 billion of issuance is scheduled for this week, which may act as a slight headwind for performance.
  • Small business optimism erodes. The NFIB Small Business Optimism Index dipped to 93.9 in January 2016 from the 95.2 reading in December 2015. Although it remains below its post-recession high of 100 (hit in late 2014) and its all-time high of 105-110 (hit in mid-2004), at 93.9 in January 2016, the index remains well above the Great Recession lows of around 80. Small business owners are finding it increasingly difficult to fill open positions (29% in January 2016, the highest reading in eight years); and, as has been the case for several years now, taxes (cited by 21%) and government regulation (cited by 18%) remain at the top of the list of small business concerns.
  • Another sign of historic volatility. Stocks staged a late-day reversal yesterday, with the S&P 500 closing 1.4% off its lows. Meanwhile, small caps found support right at their January lows before reversing higher. Nonetheless, the S&P 500 still dropped more than 1% for the 11th time this year out of 12 down days, which means 91.7% of the down days in 2016 have also been down at least 1% or more. The only day this year that was red that wasn’t also down 1% or more was a -0.04% drop on February 1. We’ve noted many times how the volatility we are seeing lately is historic, and this is yet another way of showing this. To compare, only seven years ever have had more than half of their down days down 1% or more. The most in recent memory was back in 2008, which saw 58.5% of its down days also down more than 1%. The all-time record is 71.4%, back in 1932.

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Tuesday:

  • New Hampshire Primary
  • Japan: Machine Tool Orders (Jan)

Wednesday:

  • Fed Chair Yellen Delivers Monetary Policy Testimony to Congress – House

Thursday:

  • Fed Chair Yellen Delivers Monetary Policy Testimony to Congress – Senate
  • Sweden: Riksbank Meeting

Friday:

  • Retail Sales (Jan)
  • Consumer Sentiment and Inflation Expectations (Feb)
  • Dudley* (Dove)
  • Eurozone: GDP (Q4)

Sunday:

  • China: New Loan Growth and Money Supply (Jan)
  • Japan: GDP (Q4)

Click Here for our detailed Weekly Economic Calendar

*National Association of Active Investment Managers (NAAIM) Exposure Index: Member-polled index representing average equity market exposure.

Important Disclosures

Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Stock investing involves risk including loss of principal.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio, as the principal is adjusted semiannually for inflation based on the Consumer Price Index (CPI)—while providing a real rate of return guaranteed by the U.S. government. However, a few things you need to be aware of is that the CPI might not accurately match the general inflation rate; so the principal balance on TIPS may not keep pace with the actual rate of inflation. The real interest yields on TIPS may rise, especially if there is a sharp spike in interest rates. If so, the rate of return on TIPS could lag behind other types of inflation-protected securities, like floating rate notes and T-bills. TIPs do not pay the inflation-adjusted balance until maturity, and the accrued principal on TIPS could decline, if there is deflation.

Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards.

High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.

Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.

Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.

Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

Technical Analysis is a methodology for evaluating securities based on statistics generated by market activity, such as past prices, volume and momentum, and is not intended to be used as the sole mechanism for trading decisions. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns and trends. Technical analysis carries inherent risk, chief amongst which is that past performance is not indicative of future results. Technical Analysis should be used in conjunction with Fundamental Analysis within the decision making process and shall include but not be limited to the following considerations: investment thesis, suitability, expected time horizon, and operational factors, such as trading costs are examples.

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