Last week, U.S. equities advanced, with the S&P 500 Index notching new record closes on Thursday and Friday.

Given that we’re in the sixth year of a bull market, investors are understandably getting nervous, particularly with rate and currency volatility spiking. Despite the challenges, there may be a compelling case for stocks, as I write in my new weekly commentary. Here’s why: The U.S. economy remains in somewhat of an “in-between state”, neither too hot nor too cold. This pattern was evident again last week. On the positive side, we got evidence that the labor market appears to be recovering from March’s softness. The four-week average of initial jobless claims hit the lowest level since 2000. However, at the same time, April retail sales came in flat and below expectations, a sign consumers are still not spending. On a year-over-year basis, adjusted retail sales are now up less than 1%, the slowest rate of growth since 2009.

In other words, we continue to be in an environment of decent, but not great growth. This is helping companies by keeping earnings growing just fast enough – particularly when you have the tailwind of record stock buybacks – while at the same time allowing the Federal Reserve (Fed) to keep rates low for long.

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Inflation remains low. The Fed has this latitude as inflation has barely budged. Producer prices in April unexpectedly fell by 0.4%, the latest sign of low U.S. inflation. Looking forward, inflation is likely to remain low for a variety of reasons, including the modest recovery, constrained wages and the fact that the recent rally in oil may not have much further to go. With U.S. crude prices now 25% above their March lows, U.S. exploration and production companies are considering a resumption in drilling. Any new supply would help to slow the rally and keep oil prices contained, probably in a range between $50 and $70 per barrel. This should help inflation remain both low and stable. As for what the above means for portfolios, investors may want to consider sticking with a few key themes: a preference for stocks over bonds, a healthy allocation to international equities given that U.S. stocks do look relatively expensive, and an opportunistic stance in fixed income. I don’t expect bond yields to rise sharply, but as the last few weeks have demonstrated, even a modest rise in yields will inflict some pain on portfolios.

 

Sources: Bloomberg, BlackRock

 

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog and you can find more of his posts here.

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