Mike Loewengart, Vice President of Investment Strategy
E*TRADE Capital Management
Those looking for a breakout in either direction didn’t get it this past month. And it was not for lack of action: The month kicked off with some significant volatility amid trade war fears, which then seemed to cool as it appeared the tariff talk may have more bark than bite. Things seemed rosier still as respectable economic data was released at a consistent pace. What’s more: Earnings season kicked off strong with many companies posting some of their best results in years.1
Yet towards the end of the month the equity market appeared to ignore these positive vibes, gripped by something seemingly more fearsome: The benchmark 10-year Treasury yield’s march above 3%.
Source: The Federal Reserve
This is a psychologically important level that some see as a foreboding indicator that the market is overheating and accelerated Fed action could be on the horizon.2 As the yield hit this number and inflationary concerns set in, the market dropped more than 400 points and erased monthly gains.
Some say the market move was a bit overly dramatic, and indicative of an equity market that’s seen an incredible run north and is now looking for reasons to pull back. Perhaps echoing that sentiment, the equity market recovered somewhat in the final days of the month, and all major indexes ended essentially where they started the month, and even the year.
The 10-year Treasury yield reaching 3% warrants a bit of perspective: It has no doubt weighed on investors’ minds for some time. And while many pundits have grumbled that the Fed may raise rates four times instead of the projected three, the Fed has not given too much of an indication that it would do so. Consider Chairman Powell’s remarks earlier this month: “Raising rates too quickly would increase the risk that inflation would remain persistently below our 2 percent objective. Our path of gradual rate increases is intended to balance these risks. Of course, our views about appropriate monetary policy in the months and years ahead will be informed by incoming economic data and the evolving outlook. If the outlook changes, so too will monetary policy.”3
Translation: The Fed is watching inflation closely, and will remain flexible, but isn’t eager to make any new moves yet.
This past month value outpaced growth stocks as investors likely sought out relatively better valuations.
Energy was the best performing sector as it played catch-up with the rising price of oil, while consumer staples got hammered amid rising costs and consumers turning away from traditional brands to find cheaper alternatives online.4
UK equities went on a tear as the country’s Brexit path became clearer: Markets tend to respond well to clarity.
Emerging markets took a pause from a strong run amid China suggesting that its protectionist policies may not have been as beneficial as they had hoped.5 Further, despite strength in the commodities markets, which typically benefit Latin America, this region also came under pressure as investors are potentially turning their focus to a series of critical elections across the region.
Interest rates rose across the yield curve in a mostly parallel fashion, driving prices lower across the bond spectrum. The only segment to notch a price gain this month was high-yield corporates, as the asset class tends to be closely correlated with small-capitalization stocks, which were the best performing domestic asset class.
Treasury inflation-protected securities (TIPS) were the next-best performer, down slightly on the month, but significantly outperforming taxable, investment-grade bonds, as represented by the Bloomberg Barclays US Aggregate Bond Index. With inflation rising 2% year over year in April6, as measured by the PCE index, TIPS may be appealing to investors looking to help hedge their portfolios from the negative effects of inflation.
The softest performance came from long-term Treasuries, as rates rose across the yield curve. Accordingly, bonds with the longest maturities were hurt the most.
The bottom line
Remember when the market rarely moved more than 1%? This is not that market. Volatility is center stage, and as the market seems to be responding to each new development, it is important to stay tuned. For those investors looking to make moves this month, here are a few factors to consider:
- Corporate borrowing costs are increasing. This stems from the rise in the 10-year Treasury yield discussed above. Higher yields typically mean higher borrowing costs, and this could make equities less attractive to some investors as it now costs companies more money to borrow. However, most companies have taken the opportunity to refinance at low rates, so this may take some time to play out.
- Commodities are more expensive. An early theme throughout some earnings this season has been the bemoaning of commodities costs. Caterpillar was especially vocal, noting it expects steel and other commodity costs to be “a headwind all year.”7 High commodity costs could pose a challenge for any company in the business of building products, from consumer discretionary to consumer staples, to industrials, to materials.
- Bond prices are low. The corollary of higher bond yields is low bond prices. And while bonds have certainly taken a beating of late, they should not be ignored. There’s a lot to like in this asset class, as they help provide diversification, ballast, and income. Those holding fixed income mutual funds or ETFs may be pleased to know that these instruments are busy reinvesting at higher yields, which means investors may get more juice out of their fixed income exposure over the long term.
Markets like these are what make diversification the useful tool it is. Whether it’s trade war talk, inflationary fears, or 10-year Treasury yield concerns, there will always be something to spook a jittery market. With a combination of different asset classes (such as stocks and bonds) that don’t always move in the same direction, investors have the potential to reduce overall portfolio risk and be well-positioned for the future.
As always, thank you for reading.
Vice President, Investment Strategy
E*TRADE Capital Management, LLC
Andrew Cohen, CFA
Director, Investment Strategy
E*TRADE Capital Management, LLC
Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Mike is responsible for the asset allocation and investment vehicle selections used in E*TRADE’s advisory platforms. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Early in his career, Mike was a research analyst focusing on investment manager due diligence for the consulting divisions of several high-profile investment firms. Mike holds series 7, 24, and 66 designations, as well as the Chartered Alternative Investment Analyst (CAIA) and Certified Investment Management Analyst (CIMA) designations. He is a graduate of Middlebury College with a degree in economics.
Andrew Cohen is a Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a B.S. in Finance.
1. Cox, Jeff. “Why the market is blowing off what has been a really good earnings season” CNBC, 4/24/18. https://www.cnbc.com/2018/04/24/why-the-market-is-blowing-off-what-has-been-a-really-good-earnings-season.html
2. Amaro, Silvia, “The 10-year Treasury yield has hit the 3% level — here’s what that means” CNBC, 4/25/18. https://www.cnbc.com/2018/04/25/the-10-year-treasury-yield-has-hit-the-3-percent-level--heres-what-that-means.html
3. “The Outlook for the U.S. Economy, April 6 2018.” Chairman Jerome H. Powell at the Economic Club of Chicago, Chicago, Illinois. https://www.federalreserve.gov/newsevents/speech/powell20180406a.htm
4. Otani, Akane and Wursthorn, Michael, “The ‘Amazon Effect’ Stings Consumer-Staples Stocks as Pricing Woes Mount” Wall Street Journal, 4/25/18. https://www.wsj.com/articles/the-amazon-effect-stings-consumer-staples-stocks-as-pricing-woes-mount-1524648600
5. Wei, Lingling, “Xi Pledges a More Open China, Increased Imports and Lower Auto Tariffs” Wall Street Journal, 4/10/18. https://www.wsj.com/articles/xi-pledges-a-more-open-china-increased-imports-and-lower-tariffs-1523369395
6. Bartash, Jeffry, “Inflation hits Fed’s 2% target, PCE shows, in prelude to faster rise in U.S. interest rates” MarketWatch, 4/30/18. https://www.marketwatch.com/story/inflation-hits-feds-2-target-possible-prelude-to-faster-rise-in-us-interest-rates-2018-04-30
7. Owusu, Tony, “Caterpillar Bulldozes Industrial Sector With Bad News on Earnings Call” The Street, 4/24/18. https://www.thestreet.com/markets/caterpillar-bulldozes-industrial-sector-with-bad-news-on-earnings-call-14566239