Market volatility hadn’t let up this past week: sharp swings can be seen in stocks, interest rates and oil prices. For now, we believe investing in a combination of international stocks and credit offers the best relative value. Read more on the reasons behind our rational in my weekly commentary.
With stocks, favor international
Stocks struggled last week, although the losses again were most pronounced in the United States. For January, U.S. stocks were down, while stocks in Japan, Europe and even emerging markets experienced gains. Part of the problem: The stronger U.S. dollar is negatively affecting earnings of U.S. large cap companies. This could change down the road, as benefits of cheaper energy catch up to offset that drag. In fact, a pickup in housing spending is emerging: in the fourth quarter personal consumption rose at the fastest pace since the first quarter of 2006. But for now, a fast appreciating dollar and high expectations are acting as headwinds for the U.S. equity market.
Given this dynamic, we believe it makes sense to look outside the U.S. for value. European equities are benefiting from the European Central Bank’s quantitative easing, as well as stabilization in economic indicators and improvements in lending. Japan’s market is aided by a slight decrease in the jobless rate and a pickup in industrial production. Going forward, as Japanese companies raise their notoriously low return on equity, Japanese stocks should be supported by relatively cheap valuations and rising dividends. Sector-wise, energy stocks are unsurprisingly struggling, but we see value in integrated oil companies, which could benefit from a stabilization in the price of crude.
With bonds, prefer credit
With stocks remaining under pressure, investors continued to favor U.S. Treasury debt, causing interest rates to grind lower (as prices rose). Last week, the yield on the 10-year Treasury note broke below 1.70%, the lowest level since the spring of 2013, despite an upgrade in the Federal Reserve’s (Fed’s) assessment of U.S. economic conditions. The Fed faces a difficult balancing act: trying to reconcile the competing trends of a strong U.S. labor market with a soft global economy and declining inflation expectations. Nonetheless, we still believe the Fed will increase interest rates at either its June or September meeting.
With yields down, investors are exploring other parts of the bond market that offer the prospect of higher income. We prefer tax-exempt municipal bonds, as well as U.S. high yield debt.
Oil nears its bottom?
Oil prices pushed lower for most of last week on the news that U.S. commercial crude inventories rose to the highest level for this time of the year in at least 80 years, though prices reversed sharply on Friday. While we think oil prices are approaching their bottom, we are beginning to see the dramatic impact depressed oil prices have on energy company behavior. For example, Shell announced a $15 billion cut in capital expenditures, and the number of U.S. horizontal oil rigs dropped by more than 200 in just the last two months. This slowdown in future exploration and production should lead to a price stabilization in oil.