Weekly Commentary Overview

  • U.S. equities were largely unchanged last week in what was a relatively quiet five days, although the tech-heavy Nasdaq Composite Index continued to push toward a new high.
  • Investors spent much of last week pondering what the Federal Reserve (Fed) will do with respect to raising rates in the coming months. That has helped reverse some of the recent uptick in short-term yields and made investors more cautious on rate-sensitive assets. However, there is growing comfort with other areas of the bond market, namely high yield.
  • Meanwhile, international markets continue to set the pace for stocks. Japanese equities have hit their highest levels since May 2000.
  • European assets have also performed well. However, while Friday's news should provide some short-term relief, the issue of Greece's place in the eurozone is unlikely to go away.
  • We continue to prefer international over U.S. equities, and within bonds, credit over long-term Treasuries and other rate-sensitive assets.

Few Standouts in Generally Quiet Week

U.S. equities were largely unchanged last week in what was a relatively quiet five days. The tech-heavy Nasdaq Composite Index, which continued to push toward a new high, was the only major index to notch a gain, rising 0.16% to close the week at 4,963. Meanwhile, the Dow Jones Industrial Average slipped a modest 0.04% to end at 18,132 and the S&P 500 Index fell 0.28% to 2,104. In fixed income markets, the yield on the 10-year Treasury dipped from 2.12% to 2.00% as its price correspondingly rose.

Outside the U.S., stocks largely performed better. For the first time in a while, recent economic data releases are actually favoring European equities. Meanwhile, investors continue to struggle to find income, with bond yields in most countries hitting new lows.

Europe Surpassing Expectations, U.S. Not

In contrast to the U.S., last week European and Japanese equities advanced by roughly 2.5% and 3%, respectively, extending their year-to-date gains versus the United States. As usual, fund flows offer a good barometer of investor sentiment. Money continues to flow into stocks, but investors are shifting out of U.S. equities and into non-U.S. markets. Last week witnessed the eighth straight week of outflows from U.S. equity funds, the longest streak since 2004.

Several factors are inhibiting U.S. equity returns. First, the strong dollar continues to pressure earnings for large, global exporters. The latest victim was Hewlett-Packard, whose stock tumbled after the company announced earnings would be negatively affected by the stronger dollar. As more U.S. companies struggle with the currency-related drag on exports, full-year earnings expectations for the S&P 500 have dropped roughly 1.5% over the past four weeks.

But another issue has arisen recently: While U.S. economic data continue to show decent growth, that growth is moderating. Last week, one of the better leading economic indicators, the Chicago Fed National Activity Index, fell back to zero, a significant drop from last fall. The current reading is consistent with U.S. gross domestic product (GDP) growth of around 2.5% this quarter. Indeed, most measures are coming in below expectations, with the exception of labor market statistics. Our read: The U.S. is still doing well, and is still the most robust major economy in the world, just not as well as many had expected.

In contrast, European equities are benefiting from a string of better-than-expected economic numbers, as well as a reduction in the risk associated with Greece and Ukraine. Since mid-January, there has been a meaningful improvement in Citigroup's Economic Surprise Index. The gains are not just a function of the stronger economies, like Germany, but are extending to the weaker countries on the periphery. Spain notched its fastest GDP growth in seven years.

With yields low around the world, investors are increasingly scouring the globe for income. One interesting example of the search for yield is evidenced in the recent rebound in Australian equities.

Investors Still Trying to Source Yield

Meanwhile, interest rates continue to grind lower, despite the better data out of Europe and signs that the U.S. Federal Reserve (Fed) is close to indicating when exactly it will raise interest rates. The Fed insists its course is dependent on data confirming a stronger economy, but investors continue to believe the Fed will hold back. In our view, the Fed is closer to evolving its rates policy toward more normal conditions than many in the market appear to believe. We may see a different tone from the Fed in its March meeting, leaving the door open for a June rate hike.

With U.S. economic readings coming out on the soft side and many investors believing the Fed to be in no rush to raise rates, U.S. yields have pulled back in recent weeks. The 10-year Treasury yield has retreated back to 2%. Still, this looks generous compared to Europe, where 10-year German Bund yields reached a new all-time low of 0.28% and seven-year yields moved below zero for the first time. Even in Greece, yields are falling as investors reduce the odds of a near-term Greek exit from the eurozone. The persistence of low yields is having the predictable effect of leaving investors starved for income, pushing them into bond market substitutes. Last week $2 billion flowed into equity income funds.

One interesting example of the search for yield is evidenced in the recent rebound in Australian equities. We had been negative on this market since last January and, indeed, Australian stocks had trailed global equities by roughly 6% since that time. More recently, however, Australia's market has been rebounding, despite low commodity prices and the struggles of mining companies. It seems investors found favor in Australian banks, which pay high dividends. As a result, the Australian equity market now offers a dividend yield of over 4%, more than double that of the U.S. market. With yields low around the world, investors are increasingly scouring the globe for income. That's one reason we would upgrade our view on Australian equities to a benchmark weight.

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