Stocks Bounce Back
What a difference a week makes. Stocks staged a strong rebound last week, with the Dow Jones Industrial Average climbing 2.6% to close at 16,805, the S&P 500 Index rising 4.1% to 1,964 and the Nasdaq Composite Index up 5.3% to 4,483. Meanwhile, the yield on the 10-year Treasury rose from 2.20% to 2.27%, as its price correspondingly fell.
There was no single catalyst for the rally. Equities benefited from new stimulus from the European Central Bank (ECB), positive economic data out of China, the expectation for more equity purchases by Japanese pension funds and better-than-expected earnings in the United States. Going forward, we think stocks can make further gains, and would continue to favor Japanese equities while adopting a more constructive stance on U.S. consumer stocks.
A Shift in Sentiment
Sentiment continued to improve last week with investors taking solace in the potential for expanded bond buying by the ECB, a respectable Chinese gross domestic product (GDP) report and more buying of domestic stocks by Japanese pension funds.
Equities also benefited from generally positive earnings reports from U.S. companies. To be sure, there were some notable disappointments — namely, IBM, McDonald’s and Coca-Cola — but most companies are beating expectations. So far, with 30% of S&P 500 companies having reported, earnings have grown 11.3% and revenue by 5.1%, beating expectations of 5% and 1%, respectively. Notable winners included Apple and Caterpillar, which raised its full-year guidance on expectations for better global growth. All of this was welcome news for investors worried about how a stronger dollar and slower growth might impact U.S. earnings.
Stocks were not the only asset class to benefit from the change in sentiment. Fixed income flows were $7.8 billion last week, and aside from Treasury funds, the greatest inflows were into high yield funds. As we suggested a few weeks ago, high yield became attractive during the recent sell-off. Since then, high yield bonds have rallied and the spreads versus Treasury bond yields have contracted by over 60 basis points (0.60%).
One of the reasons for the rebound in high yield is the lack of yield in other segments of the fixed income markets. With inflation remaining low throughout the world — core U.S. inflation in September came in at just 1.7%, below the Fed’s target — the yield on more traditional bonds remains stuck at low levels. This has left investors, once again, stretching for sources of income in their portfolios.