Yesterday’s Market Activity
- Major U.S. indexes little changed. S&P 500 Index flat, Dow 30 +0.1%, Nasdaq -0.3%. Durable goods orders in May (-1.2%) below expectations, highlighting concerns about slowing demand, pricing power in U.S. economy.
- Defensives gained as utilities (+0.8%) were top performers. Real estate, telecom, consumer staples also rose. Other risk-off trades included 10-year Treasury rally as yield fell to 2.13%. U.S. dollar gained traction. COMEX gold fell, however, raising questions about market’s confidence in a risk-off environment.
- Domestic, European banks rallied ~0.8% as news of $19 billion bailout of two troubled Italian banks surfaced.
Overnight & This Morning
- Asian stocks crept higher. MSCI Asia Pacific Index +0.1%, Japan +0.4%.
- European stocks plunged, led by weakness in autos. Sovereign bonds also fell slightly. Bank of England’s Carney announced higher capital targets for banks later this year.
- Draghi speech boosted euro >$1.12 as he suggested factors weighing on inflation were temporary, policymakers could look past lower oil.
- Dollar fell vs. G-10 peers, Treasury prices little changed.
- Commodities – WTI crude oil ($43.81/bbl.), gold ($1249/oz.), copper ~+0.5%.
- U.S. stocks down slightly ahead of Fed Chair Yellen’s speech later today.
- Senate Republican debate on Healthcare Bill should garner additional headlines.
- Conference Board’s Consumer Confidence Index scheduled for 10:00 a.m. ET release, forecasts for slip to 116 from 117.9 in May.
- There are many investors who are understandably concerned about the falling price of oil. Certainly, a bear market in any security will attract investor attention. Yet as we’ve discussed previously, the actions of OPEC and the emergence of the U.S. as the world’s “swing producer” given its technological leadership (hydraulic fracturing and horizontal drilling) suggest that energy price weakness is a supply-driven phenomenon, rather than an ominous demand-driven problem.
- Those investors concerned about a demand-driven problem argue that slumping oil indicates a risk of deflation, and that the Federal Reserve’s (Fed) commitment to raising rates could trigger global recession. However, two years after the price of oil began to fall from its peak in summer 2015, the global economy is on firmer footing. Bloomberg points out recent export data from Japan, South Korea, and Taiwan as examples of solid trade, and manufacturing Purchasing Managers’ Indexes (PMI) in Europe still indicate expansion, despite political uncertainty. Also, considering steady global growth (>3.0% GDP) with low inflation and low sovereign bond yields (market-based discount rates), it can be argued that global equities may continue to hover in a sweet spot in the months and quarters ahead.
- 10-year Treasury at YTD lows. The 10-year Treasury yield continued its move lower last week, closing yesterday at 2.14%. Though this yield is near year-to-date lows, it remains well above pre-election levels and the all-time low of 1.36% reached in July 2016. Moving forward, markets will have plenty of data to comb through this week, including both hard data (PCE inflation later this week), and soft data (Conference Board Consumer Confidence reading today), as well as speeches from five fed speakers including Janet Yellen.
- Yield curve flattens, but just slightly. The yield curve flattened again this week, though not by much. The 10-year Treasury moved five basis points (0.05%) lower, but the 2-year Treasury also moved two basis points (0.02%) lower, limiting the flattening to just three basis points (0.03%). A flattening yield curve often makes investors nervous, but it is important to remember that while an inverted curve has been a good historic indicator of an upcoming recession, a flattening curve has not. Though the curve has flattened back to pre-election levels, it still has a long way to go (more than 80 basis points [0.8%]) before inverting.
- Municipal bond valuations remain on expensive side. The municipal bond market typically experiences a seasonal period of higher supply in June, but this supply deluge has historically faded in July and August, creating seasonal strength for the market. We did see a supply bump in June of this year, and while we still expect seasonal strength in July and August due to declining supply, that strength may be tempered somewhat due to the fact that AAA municipal bond to Treasury yield ratios are on the expensive side currently. 10-year and 30-year ratios both cheapened slightly over the course of the week, but remain slightly elevated at 86% and 99% respectively.
- We continue to like MBS. Our constructive view on mortgage-backed securities has been rooted in the higher yield per unit of interest rate sensitivity, relative to other high quality fixed income sectors like investment-grade corporates or Treasuries. That lower duration profile has been a headwind year to date, amid the decline in longer term interest rates. However, we believe that it will be additive for the remainder of the year as longer-term rates are pushed higher by upward trending growth and inflation.
- Oil tests high-yield energy, but spillover is limited. Recent weakness in the price of oil has caused pain in the high-yield energy sector, with spreads to comparable Treasuries widening as oil fell below $45/bbl. Importantly, much of that weakness is contained, markets have been behaving and spillover to other sectors has been limited, but the situation must continue to be monitored. In this week’s Bond Market Perspectives we talk about the return of oil sensitivity in the high yield market and wrap that into our high level outlook for high yield.
- Brazilian President Michel Temer was charged with corruption on Monday, the second major political scandal in just two years. The possibility of a second corruption investigation and possible impeachment caused a significant drop in both Brazil’s stock market as well as its currency. Mr. Temer’s future as Brazilian president is far from certain; he may be able to withstand the allegations and even stay in office. The immediate reaction near the market close yesterday was positive for both the currency and Brazil’s stock market. At just over 6% of the emerging market index, Brazil is not the major country it once was in the index, though is still the largest weighting in Latin and South America.
- Conference Board Consumer Confidence (Jun)
- Richmond Fed Mfg. Report (Jun)
- Italy: Mfg. & Consumer Confidence
- Advance Report on Goods Trade Balance (May)
- Wholesale Inventories (May)
- Pending Home Sales (May)
- France: Consumer Confidence (Jun)
- Eurozone: Money Supply (May)
- Itally: PPI & CPI (Jun)
- Bank of Canada: Poloz
- Japan: Retail Sales (May)
- GDP (Q1)
- Germany: CPI (Jun)
- Eurozone: Consumer Confidence (Jun)
- BOJ: Harada
- Japan: National CPI (May)
- Japan: Industrial Production (May)
- China: Mfg. & Non-Mfg. PMI (Jun)
- Personal Income (May)
- Consumer Spending (May)
- Chicago PMI (May)
- Core Inflation (May)
- UK: GDP (Q1)
- France: CPI (Jun)
- Germany: Unemployment Change (Jun)
- Eurozone: CPI (Jun)
- Canada: GDP (Apr)
- Japan: Vehicle Production (May)
- Japan: Housing Starts (May)
- Japan: Construction Orders (May)
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) are subject to interest rate risk and opportunity risk. If interest rates rise, the value of your bond on the secondary market will likely fall. In periods of no or low inflation, other investments, including other Treasury bonds, may perform better.
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.
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High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.
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