Stocks Higher, Bonds Fall – Risk Appetite Back

By Horizon Investments

Overall, the global economy continues to show signs of strength. U.S. economic data last week was positive—with better-than-anticipated results in terms of inflation and initial jobless claims.

Likewise, international economic results were generally positive. Japanese machine orders, Italian industrial production and UK inflation were all better than expected.

Financial services stocks led the U.S. equity market higher last week, benefitting from interest rates that bounced higher from their recent lows. The energy sector also outperformed, as expectations of stronger global demand pushed energy prices higher. In contrast, softening prices for metals caused precious metals and mining stocks to underperform.

Meanwhile, developed international markets outperformed. Specifically, the European financials sector followed interest rates higher, while shares of Japanese industrial companies were boosted by the strong machine orders news. Emerging markets, especially in Asia, underperformed for week as China reported disappointing economic data.

In the fixed-income markets, corporate credits outperformed in the wake of positive equity market results. Long-duration Treasury bonds suffered the worst performance as interest rates rose sharply. Prices of such bonds are especially sensitive to changes in rates.

As geopolitical tensions eased, global financial markets continued to march higher last week. In the U.S., all three major indices hit new highs.

We continue to favor global stocks, while also maintaining a slight overweight to the aerospace and defense sector as potential downside protection against volatility that could result from North Korean military action.

The yield on the 10-year U.S. Treasury note rose by about 10 basis points last week, causing bond prices to fall, as investors began anticipating the Federal Reserve Board’s policy meeting later this week. The Gain portfolios’ fixed-income allocations remain overweight to foreign corporate debt.

Volatility once again remained extremely low among most major asset classes last week. Concerns about continued aggression by North Korea faded as attention turned to the two natural disasters in the southeast section of the U.S. The federal relief package, coupled with the resolution of the debt ceiling issue and growing interest in a bipartisan tax reform package, also helped volatility fall.

With an upward trend in place for the equity market, Risk Assist portfolios remain fully invested in an effort to capture any future gains.

With interest rates up sharply last week, broad-based fixed-income markets significantly underperformed global equities—bucking the recent trend of relative strength for bonds. Volatility subsided in most major markets and asset classes, and mid-cap and small-cap stocks both performed well last week.

In the wake of that performance, the year-to-date spread between global stocks and bonds increased and now exceeds 14%.

Long-duration bonds were hit hard last week as interest rates rose. Prices of bonds with long durations are most sensitive to spikes in interest rates.

Meanwhile, inflation (as measured by the CPI) rose by 1.9% in August on a year-over-year basis—up from 1.7% in July. More importantly, August was the first time since February that the CPI came in ahead of economists’ estimates.

This article was contributed by Horizon Investments, a participant in the ETF Strategist Channel.