- Emerging Market
- High-Yield Municipal Bonds
Weaker Opportunities for Income
Europe Takes a Breather and Yields End With a Bang
June was a bit mixed for foreign stocks. Emerging market (EM) stocks led the way with a gain of 1.04% for the month followed by Japanese stocks, which increased by 0.96%. U.S. stocks pulled ahead of Europe this month, posting a gain of 0.62% while European stocks declined by -0.45%. Currency continued to play a vital role in performance as the U.S. dollar declined relative other major currencies. In fact, European stocks did far worse in their local currency, posting a decline of -2.53% in euro terms. Bonds had a wild ride in June with the 10-year Treasury beginning the month at 2.21% and gradually sliding down to 2.14% (a year-to-date low), but jumping back up to 2.31% in the final trading days of the month. The move pushes the yield back into an earlier trading range that, if sustained, may see rates increase as much as 0.30%. For the month of June, global bonds fell 0.09% because of the increase in rates, U.S. high-yield corporate bonds increased 0.14% and EM corporate bonds were flat.
The increase in rates can largely be attributed to talks by foreign central banks to begin the tightening process. In recent days, European Central Bank (ECB) President Mario Draghi reported that many signs pointed to a strengthening and broadening recovery of the eurozone. This statement followed similar comments from other policymakers from the ECB. The United Kingdom and Canada’s top monetary policymakers also indicated that economic improvements appear to be taking hold, which led many pundits to conclude that tightening might occur soon.
Overall, leading economic indicators continue to show a synchronous expansion of the global economy and EM countries continue to surpass expectations. The JPMorgan Global Manufacturing Purchasing Managers’ Index increased from 53.6 to 53.7 (after being revised down from last month), indicating that the global economy is still in a state of expansion. While the service component of the index increased, the manufacturing component declined, but is still well above 50.0 and completes the 17th month of continued expansion.
STOCKS vs. BONDS
Interest Rate Concerns Drive the Market
Despite the run-up in U.S. interest rates at the end of June, rate-sensitive sectors performed well. The S&P 500 Financials Index increased by 6.43% and the MSCI ACWI ex-USA financials sector increased by 2.64%. U.S. technology companies have led much of the S&P 500 Index’s gain this year but declined by -2.70% for the month of June. However, despite a rotation toward lagging sectors in the month, previously leading sectors and countries still maintain a wide lead for the year. After June’s pullback, tech companies still hold a gain that is at least twice as large as any other sector besides healthcare. Many of the technical indicators appear to support a continued advance for stocks. For example, as the S&P 500 has been achieving new highs (June 19th being the most recent), the NYSE advance-decline line (a measure of the stock market’s breadth) has also achieved new highs. This tends to indicate a healthy and continuing bull market for stocks. Concurrent with strength in market breadth is the sustained low level of volatility in nearly every global market. The CBOE Volatility Index (VIX) closed at 9.75 setting yet a new multiyear low in the index. While low volatility always precedes periods of high volatility, the timing of that switch is extremely hard to pinpoint. In fact, periods of low volatility can go on for years and, when accompanied by a bull market, tend to be the best returns investors can earn. In short, there doesn’t appear to be a break in investor preference for risky assets like stocks.
On the other hand, the bond market is a bit mixed. Foreign currency strength has been a boon for foreign sovereign debt. Even Treasurys have performed well in an environment that should be unfavorable (i.e., rising rates and rhetoric of increased tightening). Certain market prognosticators have pointed to possible signs of deflation largely driven by the decline in energy prices. However, most economic indicators continue to point toward economic expansion, which should favor credit over duration. While duration has outperformed credit this year, it hasn’t been by much, which does indicate a market in flux. Until this becomes clearer, credit is likely to outperform.
What Are Rates Telling Us?
One of the indicators that we identified as being an important sign of policy outcome was the tight range of interest rates over the past several months. Since the current administration took office in January, the 10-year Treasury has held to a tight trading range between 2.30%–2.60%. This range fell apart alongside the initial unraveling of the Affordable Care Act (ACA) repeal and replace efforts. Investors clearly thought that fiscal policy changes expected under the new administration would be delayed at best and perhaps canceled altogether. Since that time, an investor could easily pin the direction of rates to the unfolding investigation into possible foreign powers meddling with the election, which was clearly distracting the administration from pushing its agenda forward. However, last week, following some hawkish commentary from top policymakers, the 10-year Treasury shot back up to 2.35% and out of the lower range it had been in for several months. While a new range has yet to be established, this move was also accompanied by renewed hopes of a Senate version of repealing and replacing the ACA. Perhaps Treasury traders have more insight into the likelihood of the latest version and the rates now reflect the inflationary pressures that could result from other administration policies. For example, as rates pushed higher, municipal bonds were one of the worst hit segments of the bond market, which have been trading at a healthy discount to Treasurys. This sell-off only makes sense if investors have a renewed confidence in a tax reform bill that has been at the center of many Republican economic plans. While nothing can be pointed to with certainty, this indicator was important early on this year and perhaps it is coming back into fashion.
One important thing to note on the report card is the rotation in trend and carry toward more defensive stock asset classes like utilities and real estate. There is also some rotation occurring in bonds as well, such as decreasing scores from EM sovereign bonds. This rotation could be signaling a larger shift toward safety and is worth of some further monitoring. This subject will likely be the focus of next month’s commentary should this trend continue.
The World’s First Quantum Satellite
China has successfully tested the world’s first quantum satellite by sending six million pairs of tiny particles from space to a series of telescopes on Earth. This endeavor is the first successful test of quantum communication that, when developed for practical purposes, could create a nearly indestructible form of cryptography. The success of these tests could also raise the profile of other quantum computing-related projects and help develop the study for a quantum internet and cloud-based computing, which would revolutionize the power of computing and open computer science to an untapped world that would literally defy the laws of physics, at least on paper.
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 Municipal Bond
||Bloomberg Barclays 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 US Treasury 1-3 yr Term
|Emerging Market Stocks
||MSCI Emerging Markets
|US Real Estate
||Dow Jones U.S. Real Estate
||Alerian MLP Infrastructure
||BofA Merrill Lynch Fixed Rate Preferred Securities
||S&P 500 Utilities Sector
|International Real Estate
||Dow Jones Global Select 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.