Stocks Hold Gains, Oil Surges

Mike Loewengart, VP of Investment Strategy

E*TRADE Capital Management, LLC

05/02/16

The Facts:

Most markets were flat in April, but that doesn’t mean there was no excitement. Far from it, in fact. Beneath the surface, developed markets rallied, and the price of oil continued its strong recovery. Read on for all the details.

The Impact:

  • Both large and small cap domestic stocks advanced in March, though just slightly.
  • Developed markets rallied on global central bank moves, outpacing emerging markets.
  • Fixed income markets ticked higher as corporate bonds gained.

What It Means for Investors:

In investing, volatility is always around the corner. But it’s not something that needs to be worrisome. We’ll take a look at how to prepare for it.

 

A Closer Look

Most major indexes advanced in April, though many ended the month not far from where they started. For instance, the S&P 500 edged higher by just 0.39%. Among the month’s big gainers were developed market equities, which rallied close to 3% on assurances from the European Central Bank, as well as on strength in Japan and the UK. The price of oil moved sharply higher during the month, offering support to asset classes across the investing spectrum—from emerging markets to high-yield debt, and more.

Fed proceeds cautiously on slower growth: Fed watchers didn’t expect an increase in interest rates when the U.S. Federal Reserve met in late April—and they weren’t disappointed. Although the Fed acknowledged improvements in the labor market, it also expressed concern about a slight slowdown in domestic economic activity. Going forward, the Fed plans to proceed cautiously—and the government’s release of gross domestic product for Q1 may explain why: Economic activity advanced just 0.5%, held back by a drawdown in inventories and relatively soft corporate investment.

No freeze on oil production: In mid-April, officials from 18 oil-producing nations met in Qatar, but could not reach an agreement to freeze oil production at current levels. The price of oil shrugged off the news, and continued to rally throughout the month. In fact, quotes on light crude futures are now up over 75% from their lows in mid-February. It also may be worth noting that, while oil prices soared in April, overall stock market indexes were generally flat. This could be the first month in quite some time where this kind of divergence has occurred, perhaps suggesting that oil will be less a primary driver of market performance going forward.

Major Asset Class Trailing Returns As of 4/30/2016

Domestic Equities

After significant moves to the upside in March, U.S. stocks ended April just modestly higher. Earnings season began with mixed results—and by month’s end, the market was pretty close to where it had started.

The large-cap-oriented S&P 500 rose 0.39% in April, and is now up 1.74% for the year so far. It may be worth remembering that, while these gains are small, they still represent a sharp reversal from late February, when the index was down over 5%.

U.S. small caps outperformed large caps for the month, with the small-cap-oriented Russell 2000 Index advancing 1.57%. Year to date, the index is now in positive territory—though just barely, at 0.03%.

There was wide dispersion among U.S. equity sectors in April (based on the S&P 500 sector indexes), with some sectors advancing sharply, and others declining by nearly as much. The energy sector was the strongest performer, extending its run from March on oil prices that continued to firm up. Materials and financials were also strong. The month’s worst performer was the IT sector, ending sharply lower on weaker earnings from a number of influential companies. Year to date, telecom, energy, and utilities have been the best-performing sectors, while IT, health care, and financials have been the weakest.

Turning to the equity styles, value stocks have been the go-to place for investors in 2016, outpacing growth for both the month and year—by a wide margin. In fact, based on the Russell 3000 Growth and Value Indexes, value is now ahead of growth year to date by over four percentage points.

International Equities

Like U.S. stocks, international equities were flat to modestly higher in April. On a comparative basis, developed markets were significantly stronger than their counterparts from emerging economies.

The MSCI EAFE Index, a widely followed measure of developed market performance, jumped 2.9% in April, the best performance of any of the major indexes we track. Japan was the strongest of the component regions in the index, even as stocks in the country sold off late on disappointment over inaction by the Bank of Japan. Year to date, developed markets are down a mere 0.20%.

Taking a breather from its prior-month rally of over 13%, the MSCI Emerging Markets Index finished up 0.54% in April. Among the index’s component regions, Latin America continued its stellar performance on further price gains for oil and other natural commodities. The index is now up 6.29% year to date.

Fixed Income

Fixed income markets advanced in April, even as yields on U.S. Treasuries inched higher. The Barclays U.S. Aggregate Index advanced 0.38% for the month, and is now up 3.43% year to date.

In the U.S. Treasury arena, the yield on the benchmark 10-year note ticked up five basis points for the month to 1.83%, and is now down 44 basis points year to date. (A basis point is one one-hundredth of a percent.) The yield curve steepened in April, but just slightly, with mixed readings for the shortest-term maturities, and advances of 5–7 basis points for maturities of five years or longer.

So why the advance in the overall bond market? While U.S. Treasuries weighed on the averages, a sector-by-sector analysis shows that corporate bonds provided countervailing strength. High-yield corporates (also known as junk bonds) were by far the month’s best performers, buoyed by renewed optimism for energy companies. (The high-yield market has significant exposure to energy.) Investment-grade corporate bonds were also strong, while long- and intermediate-term U.S. Treasuries lagged. On a year-to-date basis, long-term U.S. Treasuries, high-yield bonds, and investment-grade corporates have been the best performers, while T-bills and short-term U.S. Treasuries have been the weakest.

The Bottom Line

When it comes to investing, 2016 has been something of a rollercoaster ride. Equity markets were weak in January and February, and then exceptionally strong in March. This past month, they held on to their gains in a somewhat quieter, less choppy environment. But many investors remain concerned: What if higher volatility returns?

Our view is that volatility is a normal part of investing—and as a result, it’s not a matter of if it will return, but when. Preparing for volatility isn’t always easy, but these simple guidelines may help:

  • Play the long game. Keeping a long-term perspective may help investors weather the market’s inevitable ups and downs. One might even be able to use periodic rebalancing to capture opportunities that arise from short-term fluctuations.
  • Don’t lose sight of the big picture. Markets are still in transition from a period of extraordinarily easy monetary policy to one that’s more “normalized,” with interest rates likely to move higher along with the prospect for increased inflation. It may take some time for investors to become accustomed to these changes.
  • Diversify, diversify, diversify. Most investors can achieve sufficient diversification by holding stocks and bonds in a carefully constructed, risk-appropriate portfolio. It may be worthwhile, however, to consider deepening one’s diversification in a number of ways—for instance, by market cap (small- vs. large-cap stocks), geography (domestic vs. international stocks and bonds), style (growth vs. value), and sector. The latter can play an especially important role in fixed income investing, where opportunities may exist across sectors, including in government, corporate, and Treasury inflation-protected securities (TIPS). In short, having well-diversified investments may help give ballast to investor portfolios when markets get choppy.

Thank you for reading.

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management

 

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. 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. Mike started his career as a research analyst and an investment manager due diligence analyst for the consulting divisions of several high-profile investment firms. He is a graduate of Middlebury College with a degree in economics.