Investors had a lot to react to last week, with the biggest story being a continued rise in global bond yields. The Conservative Party secured an unexpectedly decisive victory in the U.K. elections and Fed Chair Janet Yellen commented about higher equity valuations. Chinese equities experienced their largest weekly sell-off in five years following an impressive eight-week winning streak.1 In the U.S., the S&P 500 Index gained 0.4% thanks to a strong rally on Friday following the release of April’s jobs data.1 Financials and health care were the best-performing sectors, while telecom and energy lagged.1
Weekly Top Themes
1. The labor market appears to have moved from “great” to “good.” The April jobs report showed 223,000 new jobs were created as the unemployment rate ticked down to 5.4%,2 solid numbers that were in line with expectations. Beneath the surface, there were signs of some softness, as average hourly earnings increased by only 0.1%, and the average work week was unchanged.2 All told, the report shouldn’t change expectations for Fed rate hikes.
2. Earnings are beating expectations, but overall growth is modest at best. Over 90% of S&P 500 companies have reported results, and earnings are ahead of expectations by about 7%, while revenues are in line.3 By the time the dust settles, current trends suggest first quarter revenue growth will be down 3%, earnings will be up 1% and earnings-per-share will be up 3%.3 Were it not for the energy sector, earnings growth would likely have advanced in the double-digit range.3
3. Wage growth is accelerating. The Employment Cost Index, perhaps the best measure of wage inflation, has climbed by its fastest pace in six years.2 Over the past year, the overall Index has accelerated from 1.8% to 2.6%, with wages rising 2.5% and benefits 2.7%.2
4. The long-term “dollar up/commodities down” trend will likely resume. This trend may have reached an extreme position earlier this year, and we have seen a reversal in recent weeks. While this reversal may have further to run, we have a long-term bullish view toward the dollar and believe commodities will remain under pressure.
5. The macro backdrop still appears equity-friendly. First-quarter growth was weak, but we expect to see a rebound. The Fed is gearing up for rate increases (likely at some point in the fall), but such a shift is unlikely to be dramatic enough to cause long-term issues for equities. Corporate earnings are hardly robust, but have been better than feared. We expect conditions will improve in the coming months, which should allow for further advances in stock prices.
Equities Should Withstand Rising Global Bond Yields
U.S. equities fared relatively well in the first quarter despite softening growth. However, a different factor now threatens to disrupt the bull market: rising bond yields. Since economic sentiment has not yet fully recovered, the threat of higher rates is prompting some additional equity market volatility. U.S. Treasury yields fell earlier in the year in the face of weaker growth, but have since rebounded and are close to the same level where they began 2015.1 Outside of the United States, Europe is still recovering, although the pace may be tapering off. Japan is still struggling and requires a revival in global trade. And Chinese growth continues to slow. In all, we view the global economy as improving but still in need of policy support in many areas.
The good news for equities is that both U.S. and global growth appear to be improving. We expect government bond yields to rise in the coming months, however, which will put this area of the market under pressure. A combination of higher inflation expectations, solidifying global growth and a shift in Fed policy is likely to drive yields higher.
If bond yields were to rise quickly and dramatically, it could trigger an equity market correction. Given ample liquidity and still-easy global monetary policy, however, we are expecting a more benign bond yield advance. As such, we expect to see additional turbulence in equities when the Fed raises rates, but we believe this bull market still has room to grow.
1 Source: Morningstar Direct, and Bloomberg as of 5/8/15
2 Source: Bureau of Labor Statistics
3 Source: RBC Capital Markets
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
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The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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