Stocks Climb Higher in a Volatile Week
Global stocks finished last week with solid gains, but not without wild gyrations along the way. In the U.S., the Dow Jones Industrial Average climbed 3.03% to close the week at 17,804, the S&P 500 Index rose 3.40% to 2,070, and the Nasdaq Composite Index was up 2.40% to 4,765. Meanwhile, the yield on the 10-year Treasury inched up from 2.10% to 2.17%, as its price correspondingly fell.
Last week may be a prelude to what's to come, as we expect more episodes of volatility as we enter the new year. An important driver of that volatility will be markets adjusting to less accommodative U.S. monetary conditions. But on top of that, investors will continue to wrestle with several lingering geopolitical issues, particularly with respect to Russia.
U.S. Growth Provides a Tailwind for Stocks …
Despite the severe volatility last week, global equity markets, at least in the developed world, managed to finish with solid gains. Emerging markets performance was more mixed, underscoring our recommendation to be selective in this space. Notably, Chinese equities continued to outperform, up more than 5% last week.
Here at home, stocks were helped by more evidence of U.S. economic strength. Industrial production rose 1.3% last month and is now up 5.2% year-over-year, the fastest pace in almost four years.
The fact that the U.S. economy is entering 2015 with strong momentum should help company earnings growth, allowing stocks to move higher next year. And while valuations are not cheap, they are supported by low inflation and ultra-low bond yields. U.S. Treasury yields did rise a bit last week, but the general trend toward low global yields continues. Last week, 10-year German bund yields fell to Japan-like levels of 0.60%. Low yields mean investors will continue to look for opportunities in stocks, rather than bonds, which should support the equity market.
The drivers of the low-yield environment are falling inflation (contributing to low nominal gross domestic product), a lack of supply of bonds and shifting demographics. For its part, inflation remains low even in the U.S. despite decent economic activity. In November, the U.S. consumer price index fell 0.3%, the biggest one-month drop since 2008. The decline was largely driven by energy prices, but core inflation remains low at 1.7% year-over-year.
Short-term interest rates are likely to rise next year, but the lack of inflationary pressure is providing the Federal Reserve with considerable latitude as it considers raising rates. On Wednesday, the Fed issued a statement that slightly changed the language in its guidance with respect to rate hikes. The Fed added a new clause, indicating that it would be "patient before raising rates," a seemingly minor nuance that helped ease concerns of a sudden hike in rates.