Last week, investors multi-tasked, pushing both U.S. bond and stock markets higher.
In March, the Federal Reserve raised the Fed funds rates for the second time in three months. Typically, we would expect interest rates to rise and bond prices to fall, but interest rates have been falling and bond prices have been moving higher. Barron’s reported yields on 10-year Treasuries hit their lowest levels since the election last week.
Reuters explained there has been a shift in expectations:
“Bonds prices have been boosted in recent weeks by reduced expectations that the Federal Reserve will raise interest rates two more times this year, following disappointing economic data releases. Still, Fed Vice Chair Stanley Fischer said on Friday that two more U.S. rate increases this year remain an appropriate plan for the Federal Reserve despite some weak recent economic data.”
Geopolitical anxiety continued to play a role in market performance, too, causing investors to flee to safe havens, which contributed to bond market strength.
Geopolitics didn’t cause U.S. stock markets to swoon, though. Barron’s reported:
“Stocks’ on-again, off-again rally was on again last week, and it took the Standard & Poor’s 500 index to within sniffing distance of its March 1 record. Climbing in the face of geopolitical anxiety from Paris to Pyongyang is bullish, as is preserving the upward slope of the index’s 200-day average. But there are signs of wavering conviction…”
That wavering conviction is found in investors’ preference for a small group of tech stocks, as well as more defensive sectors of the market. Through mid-April, just 10 stocks accounted for one-half of the S&P 500’s gain during 2017.
A possible motto for 2017: Expect the unexpected.
And the survey said...
In late 2016, Natixis Global surveyed 500 institutional decision makers representing corporate pension plans, public pension plans, sovereign wealth funds, insurance companies, foundations, and endowments. Survey participants said market volatility, geopolitics, and interest rates were their top risk concerns for 2017.
So far, U.S. stock markets haven’t proven to be very volatile, but geopolitics caused some disruption last week. Barron’s reported:
“Stocks fell 1 percent last week in quiet trading, with many market participants out for religious observances. Worries about the war in Syria, North Korean saber-rattling, and the coming French elections had investors reining in riskier positions and heading for safe havens.
Real estate, utilities, and consumer-staples stocks were the only sectors that rose last week. Financials – and banks in particular – fell, despite strong earnings reports from the industry’s big kahunas.”
It was a tough week for stocks, but investors’ flight to safety caused Treasury bonds to rally. Reuters reported the interest rate on 10-year Treasury notes fell 14 basis points. That’s the biggest weekly decline since January 2016. (There is an inverse relationship between bond interest rates and bond prices. When interest rates fall, bond prices rise, and vice-versa.)
U.S. stock markets are sending mixed signals.
If you look at the performance of the CBOE Volatility Index (a.k.a. the VIX or fear gauge), which is a measure of market expectations for volatility in the near future, it appears all is well and investors expect no unexpected events. Barron’s explained:
“…which brings us back to a central fact: the absence of volatility. The first quarter was historic for the CBOE Volatility Index...It ranged from 10.6 to 13.1, and its average level was 11.69, the lowest in an initial quarter since the VIX was born in 1990 and the second-lowest quarterly average since the 11.3 of 2006’s final three months...”
The VIX remained stubbornly low last week, too, despite weaker than expected employment news, wage news, and generally flat economic data.
If you turn your eyes to the number of companies whose shares have reached new highs, you might form a different opinion about the steadiness of stock markets. Barron’s wrote:
“…the squadron of stocks pushing 52-week highs at the New York Stock Exchange has shrunk from 338 on March 1 to 72 late last week…But, if the planet really is enjoying a synchronized economic recovery, why are we lunging at these stocks as if they were the only game in town?”
It’s difficult to know how to factor in last week’s air strikes against Syria, which registered as a tiny blip on the U.S. stock market radar. Some analysts say that’s as it should be. The real drivers of market performance in 2017 will be tax reform and global monetary policy. Others are concerned involvement in Syria could lead to a reshuffling of political priorities and delay progress on domestic legislation.
In times like these, diversification is critical.
Toward the end of the first quarter, the bull market celebrated its eighth birthday. David Kelly, Chief Global Strategist at J.P. Morgan Asset Management wrote:
“Eight years ago, on March 9, 2009, the S&P 500 closed at 677, down 57 percent from where it had been just 18 months earlier. 10-year Treasury yields had fallen from 3.6 percent to 2.9 percent over the previous year…Investors were depressed and scared. However, good long-term returns from stocks were almost inevitable at that point since economic and market fundamentals were at unsustainably low levels…Eight years later, the financial landscape has changed completely…it still makes sense to be in long-term investments including both domestic stocks and bonds. However, it is time to adopt a more diversified and thoughtful approach that recognizes the importance of valuations…”
Valuations were heady during first quarter
Stock valuations reflect how much a share of a company’s stock, or shares of companies in an index, may be worth. Valuations can help investors understand whether shares are expensive, reasonable, or inexpensive. One way to measure valuation is to look at trailing 12-month price-to-earnings (P/E). This gauge reflects how much an investor must pay to receive one dollar of the company’s earnings.
For instance, on March 31, FactSet reported the trailing 12-month P/E of the Standard & Poor’s 500 Index was 21.8. That’s well above the 10-year average of 16.6 and the five-year average of 17.1. This suggests shares of the overall index are expensive. Keep in mind, even when the index appears to be expensive, the valuations of specific companies or sectors within the index may still be attractive.
Animal spirits abounded
The CEO of JPMorgan attributed investors’ enthusiasm for stocks during the first quarter to ‘animal spirits,’ reported CNN Money. Animal spirits is a term coined by John Maynard Keynes. It describes “…a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." Investors were inspired by the new administration’s growth agenda, including promises of lower taxes and less regulation.
The U.S. economy grew (but we’re not sure how much)
People and businesses may have been more enthusiastic than data suggests they should be. Financial Times cited research from Morgan Stanley that shows a growing gap between ‘hard’ economic data (like slowing corporate spending and lower retail sales) and ‘soft’ economic data (like consumer and business optimism). The disparity has created uncertainty about the pace of economic growth during the first quarter of 2017. “The Atlanta Federal Reserve’s model, which…focuses on hard data, projects an annualized rate of just 1 percent. However, the New York Fed’s model, which ‘incorporates soft data into its tracking,’ forecasts 3 percent growth.”
The Federal Reserve acted
With employment and inflation data approaching Fed targets, the Federal Open Market Committee raised rates in March, pushing the Fed funds target rate into the 0.75 percent to 1 percent range, reported Financial Times. More rate hikes are expected during 2017.
Brexit was launched
The end of the first quarter of 2017 marked a new beginning for Britain. On March 29, Prime Minister Theresa May officially launched Britain’s exit from the European Union. The United Kingdom now has two years to negotiate terms with the European Union (unless all members of the EU unanimously approve an extension).
When you consider how long trade agreement negotiations normally take, it appears the task ahead for Britain and the EU is akin to running a marathon in 30 minutes. For example, Canada and the EU began discussing a trade agreement in 2007. It has yet to be finalized.
United States and European national stock market indices finished the quarter higher.