Stocks Retreat After Hitting a New Record
Stocks initially pushed higher last week, with equities in the United States hitting a new record before retreating on Friday. For the week, the Dow Jones Industrial Average slipped -0.10% to 16,969, the S&P 500 Index edged up 0.12% to 1,978 and the tech-heavy Nasdaq Composite Index climbed 0.39% to 4,449. Meanwhile, the yield on the 10-year Treasury dipped slightly from 2.48% to 2.46%, as its price correspondingly rose.
A generally positive tone to earnings season supported stocks last week, but investors finally showed some signs of fatigue, or at least general nervousness, over what has become fairly lofty stock prices. Last week saw aggressive selling of risky assets, including U.S. equities and high yield bonds. On the latter, we would expect more volatility in the near term, but for long-term, income-oriented investors, high yield still represents a good source of income.
Earnings Season Lends Support
A decent second-quarter earnings season lent support to stocks. In the United States, roughly 80% of companies reporting earnings have beaten analysts’ profit estimates, while 69% exceeded sales projections. Profits at S&P 500 companies appear to be on a pace to rise 6.2% in the second quarter, with sales gaining 3.3%, both comfortably ahead of analyst estimates. Last week witnessed strong earnings from key companies including Microsoft, Facebook and AT&T.
Even Europe, where earnings have disappointed the last few quarters, is showing some improvement. A healthy 65% of European companies have beat expectations, versus a historical average of 62%.
A Surprising Sell-Off
Still, what is interesting is that despite the genuinely positive tone to earnings, investors appear to be selling the rally. We saw $4.2 billion exit global exchange traded products last week, representing the first weekly outflow since late May. Selling was particularly aggressive for U.S. large caps, which lost $6.8 billion, while European equities lost $600 million in their third straight week of outflows. Emerging markets defied the trend. A shift in investor sentiment made it one of the few segments to experience inflows.
High Yield Hit Hard
Outflows were particularly pronounced for U.S. high yield bonds.
High yield is often thought of as the most “equity-like” segment of the bond market. Still, we find the recent outflows somewhat surprising. The interest rate environment has remained remarkably stable, with the yield on the 10-year U.S. Treasury stuck around 2.50%. Investors have continued to buy bonds amid persistent geopolitical unrest and a stable inflation environment. Indeed, last week provided more evidence that inflation is not an imminent threat. U.S. consumer inflation was in line with expectations, up 2.1% year-over-year, while core inflation actually surprised to the downside with a 0.1% increase. This put the year-over-year number at 1.9%. Despite recent fears over higher prices, for now, core inflation remains well anchored at its10-year average.