- Emerging Market
- High-Yield Corporate Bonds
- High-Yield Municipal Bonds
Weaker Opportunities for Income
Rates and Inflation Creep Higher
March strongly favored foreign stocks over domestic stocks. International developed stocks increased by 2.8%, slightly outperforming emerging market (EM) stocks, which increased by 2.5%. U.S. stocks managed to finish the month with a slightly positive return of 0.1%. Overall, U.S. markets didn’t favor income-producing stocks, as utilities, U.S. real estate and MLPs all declined during March. Global bonds increased by 0.2% during the month with foreign bonds outperforming domestic bonds. International and emerging market sovereign bonds increased by 0.3% and 0.4%, respectively, while U.S. Treasurys fell -0.1%. Even credit-sensitive sectors such as high-yield corporate bonds fell -0.2%.
The Federal Open Market Committee (FOMC) increased the federal funds rate by 0.3% in March, the second increase in three months. The committee continues to indicate an expectation of at least two more increases this year. The indication of further rate hikes appears to be consistent with data like the continuation of inflation, which has now grown at 2.7% year-over-year—the highest level since January 2012. The changing economic backdrop appears to be consistent globally as even the European Central Bank is warning banks, investors and governments to expect higher interest rates and to plan accordingly.
The JPMorgan Global Manufacturing Purchasing Managers’ Index (PMI) Composite fell slightly from 53.9 to 53.5 due to a slowdown in the service sector. Though manufacturing remained fairly flat, a number over 50 tends to indicate an expectation of continued economic growth.
STOCKS vs. BONDS
Since the beginning of 2017, a clear trend has emerged in regard to the relationship between stocks and bonds. The 10-year Treasury has maintained a tight pattern between 2.3% and 2.6% year to date. As this rate increases, higher risk assets such as such as stocks and credit rally at the cost of safer assets like Treasurys. This pattern reverses as yields fall. Behind this tug of war is a steadily increasing correlation between stocks and bonds, which diminishes the diversification benefits of bonds and is typical of a rising rate environment. Looking ahead, this range is important to watch as it is one of the key macroeconomic conditions driving the current market. Should rates break out to the positive side, reflationary themes from last year will likely continue, resulting in higher stock prices, higher commodity prices and tighter credit spreads. A breakdown in yields will likely be the result of further policy conflicts in the federal government, which might result in a lower probability for tax reform, trade reform and other inflationary policies that were expected from the Trump administration and the Republican-led Congress. In this circumstance, we could expect a sharp reversal, favoring safe stocks, such as utilities, and less credit-sensitive bonds, likely Treasurys. However, it doesn’t seem prudent to trade on either of these assumptions at this juncture. Instead, we continue to let the market indicate the direction of possible market leadership.
So Far, So Good
We started the year favoring EM stocks, high-yield bonds, high-yield muni bonds and EM corporate bonds. So far, the MSCI Emerging Markets Index has increased by 11.44% in 2017 while the MSCI ACWI has increased by 7.05%. High-yield bonds, high-yield muni bonds and EM corporate bonds have increased by 2.7%, 4.1% and 2.9%, respectively, while global bonds increased by 1.8%.
We expected outperformance from credit sectors since these perform better in a rising rate environment. Rates have been volatile but are about where they were at the beginning of the year. As a result, credit sectors have outperformed, but the relative outperformance is lower than we would have expected. One of the surprise winners this year is the international sovereign sector, which has increased by 2.7X%. We have warned about this asset class in the past. The yields on these types of bonds are extremely low and, in some cases, even negative, which gives very little room for price appreciation. We feel it is still a very risky sector of the market.
As discussed previously, it is hard to clearly indicate a path for both stocks and bonds going forward because of the tight trading range of interest rates. As of now, we don’t think there is much threatening our outlook for the year, which favors stocks and credit. We believe the global economy is continuing to grow and forward-looking indicators, such as the JPMorgan Global Manufacturing PMI Composite, suggest that the private industry expects that to continue. Once we get a clearer indication as to the path of market, we can adjust our outlook accordingly. However, we still expect our outlook to remain intact.
March Madness Brackets
To date, there is no record of anyone ever filling out a perfect NCAA basketball bracket. The odds of building a perfect bracket is a hotly debated subject, but the estimates go as high as one in 9 quintillion; the exact numbers are probably irrelevant since it is effectively impossible. The American Gaming Association estimates that nearly 70 million brackets are filled out every year. Many are duplicates, so it estimates that the number of people making forecasts is around 40 million. With that, congratulations to North Carolina for winning the 2017 NCAA Men’s Basketball Championship.
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
||Bloomberg Barclays Municipal Bond
||Bloomberg Barclays Muni High Yield
|U.S. High-Yield Corporate
||Bloomberg Barclays U.S. Corp High Yield
|Emerging Market Corporate
||CS Emerging Markets Corporate Bond
|Emerging Market Sovereign
||Bloomberg Barclays EM Sovereign
||Bloomberg Barclays Global Treasury ex USD
||Bloomberg Barclays U.S. MBS
|Short Term Treasurys (Cash Proxy)
||Bloomberg Barclays US Treasury 1-3 yr
||S&P 500 Index
|Emerging Market Stocks
||MSCI Emerging Markets
|US Real Estate
||Dow Jones US 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 US 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 U.S. excluded while hedging the currency back to the U.S. 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. 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 with a maturity between one and up to (but not including) three 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.
Brexit a term for the potential or hypothetical departure of the United Kingdom from the European Union.
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.
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 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.
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.