• The market selloff has pushed stocks into negative territory for the year.
  • Within equities, a focus on value styles continues to make sense.
  • Some investors may be stretching too far to find yield—we believe fixed income sectors such as high yield and municipal bonds warrant attention.

Markets Sell Off, Led by Growth Stocks

Over the past couple of weeks, we have been talking about a market trend in which growth stocks (particularly in areas such as biotechnology and social media) have been underperforming the rest of the market. That trend continued last week and helped drive the broader stock market averages lower. For the week, the Dow Jones Industrial Average lost 2.3% to close at 16,026, the S&P 500 Index declined 2.7% to 1,815 and the Nasdaq Composite shed 3.1% to 3,999. With these losses, U.S. stocks are now in negative territory for the year.

Last week also saw some modest movement in fixed income markets, with the yield on the 10-year Treasury dropping from 2.72% to 2.63% (as Treasury prices correspondingly rose). With rates still near their historic lows, many investors are moving toward more speculative, higher-yielding areas of the fixed income market—and as we discuss below, these decisions may be causing them to take on undue levels of risk.

"Both high yield and municipals appear fundamentally attractive, offer decent yields and the prospects for relatively low volatility."

The Move Toward Value Continues to Make Sense

The fact that growth styles have lagged for several weeks now is having a meaningful effect on the relative year-to-date performance of various areas of the market. The broad U.S. equity market is still trading within 3% to 4% of its recent all-time high, but certain areas of the market are down much more sharply. U.S. small caps are down 8%, Internet companies are off 18% and the biotechnology industry has lost 22% since the recent market high.

Some of these declines can be attributed to stretched valuations. The Nasdaq Biotechnology Index, as an example, is currently trading at prices that are 8X sales, compared to less than 2X for the broader market. The selloff in growth and momentum stocks is also being exacerbated by what appears to be heavy selling of these names by hedge funds. Given these trends, we continue to believe investors should emphasize value styles of investing, a strategy that has paid off in recent weeks.

With Rates Likely to Stay Low, Investors Are Stretching for Yield

Although we continue to believe rates are likely to move modestly higher over the course of the year, so far the opposite has occurred in 2014. Part of the downward drift in Treasury yields can be attributed to investors moving into safe-haven assets as part of an overall sentiment of heightened risk aversion. But an additional factor that has kept yields low is diminishing fears over an imminent rate hike by the Federal Reserve.

In the immediate aftermath of last month's Fed meeting, there was a sense that the Fed might be planning to raise the fed funds rate earlier than previously anticipated. Last week's release of the minutes from the Fed's March meeting, however, made it clear that the central bank had no such plans. The minutes confirmed that the Fed did not intend to convey a more hawkish stance and, in fact, plans to keep rates low for some time.

Stubbornly low yields have made income tough to come by in recent years, and that has sent investors searching for yield and income wherever they can find it. While we support the idea of looking for income in new places, doing so without careful consideration of the risks can be a dangerous prospect. Recently, we have seen a few instances in which investors are stretching for yield, despite the fact that the risks may not be worth it. One recent example was an auction for Greek bonds that was highly oversubscribed and garnered much more investor attention than could have been imagined during the recent height of the European debt crisis.

For those investors who are looking for additional yield, we think there are better alternatives to stretching too far for yield and ignoring risks. While there are no absolute bargains in fixed income markets today, there are some asset classes that offer good relative value, including high yield and municipal bonds. Both high yield and municipals appear fundamentally attractive, offer decent yields and the prospects for relatively low volatility.

Featured Insight

High Yield Bonds and Loans:
Still Have Legs

The municipal bond market has long and still represents a unique, tax-advantaged income solution. It is also a market in evolution. Peter Hayes, Head of the BlackRock Municipal Bonds Group, explains.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 14, 2014, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

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