- Emerging Market Corporate Bonds
- High-Yield Municipal Bonds
- International Real Estate
Weaker Opportunities for Income
- International Sovereign Bonds
Emerging Markets Continue to Surge
July was generally a good month for all global markets as the MSCI All Country World Index increased by 2.79% led by the emerging markets (EM), which increased by 5.96%. EM was led by some of the larger economies, including China and India, which increased by 8.89% and 7.70%, respectively. U.S. stocks reached new highs in July as the S&P 500 Index increased by 2.06% and the CBOE Volatility Index reached record lows. From a sector standpoint, it is hard to put a label on July’s increase in the S&P 500 as the top sectors were a mix of 2017 favorites, such as technology, and some of 2017 laggards, such as telecom. Europe outperformed the U.S. and increased by 2.99% led by some of the peripheral economies such as Portugal and Ireland, which increased by 5.42% and 4.67%, respectively.
This year, we think it has been important to pick apart performance and review some of the key drivers. Europe’s stock rebound has largely been driven by an increase in the euro relative the dollar. For example, the MSCI Europe Index is up 19.53% year-to-date in U.S. dollars, but up a less impressive 6.73% in euros. EM on the other hand is up 25.49% year-to-date in U.S. dollars, but is still up substantially in local currency (18.73% for the year). It is important to note that Europe is mainly benefitting from a strengthening currency while EM, though still benefitting from currency strength, is growing from organic sources, such as increasing earnings.
Bonds also finished a strong month in July as global bonds increased by 1.68% with a yield of 1.59%. International sovereign bonds continue to lead the market, increasing by 2.50% in July. Euro bonds have led the charge among sovereign bonds, increasing by 3.61% for the month, followed by Japanese government bonds, which increased by 1.76% for the month. U.S. high-yield bonds, EM corporate bonds and EM sovereign bonds also posted a strong month, gaining 1.11%, 1.18% and 0.66%, respectively.
Again, we have to peel back the performance. In U.S. dollar terms, euro bonds posted a gain of 10.94% in 2017 and Japanese government bonds gained 5.28% over the same period. Once again, the gains evaporate in local currencies; euro bonds decreased by -0.75% in euros and Japanese government bonds fell -0.34% in yen on the year. While euro bonds may appear to provide a great return for a fixed-income investment, keep in mind that you’re only getting a paltry 0.63%, which provides very little cover in the event of rising rates (and rates are currently rising). Additionally, the currency effect dramatically increases the volatility, which is at 9.88% annualized year-to-date. By comparison, the S&P 500 has outperformed euro bonds at an annualized volatility of 8.10%. In other words, stocks may provide better returns and realize better volatility.
STOCKS vs. BONDS
Valuations Continue to Rise
The S&P 500 finished July at 21.33x earnings and we think it is pretty much impossible to find a part of the market that could be called undervalued. Europe finished the month at 22.12x earnings and emerging markets were at 16.21x earnings. Bonds do not offer any better valuations as U.S. high-yield has an option-adjusted spread that is at the lowest level in 20 years. For long-term investors, this situation may be difficult as it is tough to come up with a long-term expected return for stocks that doesn’t hover around 2%. We think any new investor to stocks might want to take note of that and make sure that the investment strategy provides some cover if stocks pull back from their current levels.
Shorter term, it might not be such a big deal. One valuation indicator that has worked well since the financial crisis is relative yield of stocks and bonds. At the end of July, the S&P 500, EM and Europe yielded 1.97%, 2.35% and 3.37%, respectively, while global bonds yielded 1.59%. With stock volatility lower than bond volatility in some cases, it paints a strong picture for stocks. However, we are likely closer to the end of this bull market than the beginning. U.S. aggregate bonds are currently yielding 2.51%, which is higher than the S&P 500—a relatively new phenomenon thanks to rising rates. On the other hand, euro aggregate bonds are yielding 0.59%, which makes a strong case for European stocks over U.S. stocks.
Regardless of valuation, we think there is still a strong case for stocks over bonds, at least in the near term. The NYSE Advance/Decline Indicator achieved a new high on July 25th while the S&P 500 achieved a new high on July 26th. Additionally, NYSE New Highs/Lows is still favoring a bullish condition for stocks. Finally, the JPMorgan Global Manufacturing Purchasing Managers Index is at 53.7, indicating that the global economy is still in expansion. Therefore, for now, we think it still pays to take some risk.
Is There a Rotation?
Last month, we discussed the possibility of a rotation toward more defensive asset classes and whether it signaled that investors were starting to rotate to safer parts of the market. At this point, it would be hard to conclusively state this rotation as fact. In July, defensive sectors such as utilities and telecoms were some of the top performers, but so were more growth-oriented sectors such as energy and tech. Additionally, EM stocks, which are typically associated with riskier investors, were the best performing in the market while commodities and commodity-sensitive markets performed well, including Canada and Australia increasing by 3.95% and 4.45%, respectively, outperforming the global stock market. Again, these are the types of positions investors take when they are confident in global economic growth.
On the other hand, the trend for safer bonds has been improving. Our report card shows that investment-grade credit, along with cash, has moved into a higher ranking while high-yield municipal bonds have declined. This movement does appear to be a rotation into safety, but some of the rotation might be associated with improving odds of tax reform, which could change the economics of any type of municipal bond. Other credit-sensitive bond sectors like U.S. high-yield bonds, EM corporate debt and EM sovereign bonds are still ranked near the top in terms of trend and carry.
Given all this, it is safe to say that there isn’t a broad-based rotation into safety as the trend still favors the riskier segments of the market and investors usually follow that trend.
Are We Alone in the Universe?
Scientists at Columbia University published findings that could indicate the discovery of the first exomoon—a moon orbiting a planet orbiting a distant star. This type of structure is believed to be the best place to search for extraterrestrial life. The team reviewed 284 possible candidates searching for a pattern of shadows that could indicate the existence of an exomoon. So far, the data is consistent with the presence of this type of celestial body. On October 29th the team will use the Hubble Space Telescope to see if the moon is really there.
To learn more about the methodology visit the Salient Partners Income Investing blog series Part 2. You can also follow us on Twitter at @nrowader and @NicMillikan for live updates on the Income Report Card.
Report Card: Stocks
Report Card: Bonds
ASSET CLASS KEY
||Bloomberg Barclays U.S. Treasury
|U.S. Investment Grade Credit
||Bloomberg Barclays U.S. Credit Bond
||Bloomberg Barclays U.S. Municipal Bond
||Bloomberg Barclays U.S. Municipal High Yield
|U.S. High-Yield Corporate Bonds
||Bloomberg Barclays U.S. Corporate High-Yield Bond
|Emerging Market Corporate Debt
||CS Emerging Markets Corporate Bond
|Emerging Market Sovereign Debt
||Bloomberg Barclays EM Sovereign Bond
|International Sovereign Debt
||Bloomberg Barclays Global Treasury ex-USD
||Bloomberg Barclays U.S. MBS
|Short-Term Treasurys (Cash Proxy)
||Bloomberg Barclays U.S. Treasury 1-3 yr Term
|Emerging Market Stocks
||MSCI Emerging Markets
|U.S. Real Estate
||Dow Jones U.S. Real Estate
||Alerian MLP Infrastructure
||BofA Merrill Lynch Core Fixed Rate Preferred Securities
||S&P 500 Utilities Sector
|International Real Estate
||Dow Jones Global ex-U.S. Real Estate Securities
||MSCI EM Infrastructure
Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.
This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.
Nathan J. Rowader is a registered representative of ALPS Distributors, Inc.
Alerian MLP Infrastructure Index is the leading gauge of large- and mid-cap energy master limited partnerships (MLPs). The float-adjusted, capitalization-weighted index includes some of the most prominent companies and captures approximately 75% of available market capitalization.
Bloomberg Barclays EM Sovereign Bond Index is a rules-based market-value weighted index engineered to measure the fixed-rate local currency sovereign bonds issued in emerging markets as identified by Bloomberg.
Bloomberg Barclays Global Treasury ex-USD Index is an unmanaged index composed of those securities included in the Barclays Global Aggregate Bond Index that are Treasury securities, with the US excluded while hedging the currency back to the US dollar.
Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are U.S. domestic, taxable and dollar denominated. The index covers the U.S. investment-grade, fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities and asset-backed securities.
Bloomberg Barclays U.S. Corporate High-Yield Bond Index covers the USD-denominated, noninvestment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.
Bloomberg Barclays U.S. Credit Index is an index composed of corporate and non-corporate debt issues that are rated investment grade (Baa3/BBB) or higher.
Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC).
Bloomberg Barclays U.S. Municipal Bond Index covers the USD-denominated, long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds.
Bloomberg Barclays U.S. Municipal High Yield Index measures the noninvestment-grade and nonrated U.S. dollar-denominated, fixed-rate, tax-exempt bond market within the 50 United States and four other qualifying regions (Washington D.C., Puerto Rico, Guam and the Virgin Islands).
Bloomberg Barclays U.S. Treasury Index is an unmanaged index of public obligations of the U.S. Treasury with a remaining maturity of one year or more.
Bloomberg Barclays U.S. Treasury Bond 1-3 Year Term Index is an unmanaged index of public obligations of the U.S. Treasury includes public obligations of the U.S. Treasury with a maturity between 1 and up to (but not including) 3 years.
BofA Merrill Lynch U.S. Core Fixed Rate Preferred Stock Index consists of investment-grade, fixed and fixed-to-floating rate U.S. dollar-denominated preferred securities.
Consumer price index (CPI) is an index number measuring the average price of consumer goods and services purchased by households. The percentage change in the CPI is a measure of inflation.
Credit Suisse Emerging Market Corporate Bond Index consists of U.S. dollar-denominated fixed-income issues from Latin America, Eastern Europe and Asia.
Dow Jones Global ex-U.S. Select REIT Index measures the performance of equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded globally, excluding the U.S.
Dow Jones U.S. Real Estate Index measures the performance of the real estate industry of the U.S. equity market.
JPMorgan Global Manufacturing Purchasing Managers’ Index is a composite index that serves as a global economic indicator by measuring different business conditions in 24 countries, including global manufacturing output, new orders and employment across the global manufacturing sector.
MSCI EAFE (Europe, Australasia and Far East) Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. and Canada.
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
MSCI Emerging Markets Infrastructure Index captures the global opportunity set of companies that are owners or operators of infrastructure assets.
MSCI Europe Index is a free float-adjusted market capitalization index designed to measure developed market equity performance in Europe.
MSCI World Index is a free float-adjusted market capitalization index designed to measure equity market performance in the global developed markets.
Max drawdown is the percentage of loss that an asset incurs from its peak net asset value to its lowest value.
NASDAQ-100 is a modified capitalization-weighted index that includes the largest nonfinancial U.S. and non-U.S. companies listed on the NASDAQ stock market across a variety of industries, such as retail, healthcare, telecommunications, wholesale trade, biotechnology and technology.
Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The Russell 3000 Index represents approximately 98% of the investable U.S. equity market.
S&P 500 Index is an unmanaged index of 500 common stocks chosen to reflect the industries in the U.S. economy.
Sharpe ratio is a ratio developed by Nobel laureate William F. Sharpe to measure how a fund performs relative to the risk it takes.
Standard deviation measures the degree to which a fund’s return varies from its previous returns or from the average of all similar funds.
Valuation is the process of determining the value of an asset or company based on earnings and the market value of assets.
VIX (the ticker symbol for the Chicago Board Options Exchange Volatility Index) is a popular measure of market risk and is constructed using the implied volatility of S&P 500 index options.
Yield is the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost or on the U.S. government’s debt obligations.