U.S. Stocks Exhibit Some Vigor
Equities rose last week, with U.S. markets finally showing some signs of strength. The S&P 500 Index rose 1.74% to 2,102, the Dow Jones Industrial Average grew 1.58% to 18,057, while the Nasdaq Composite Index climbed 2.23% to close the week at 4,996. As for bonds, the yield on the 10-year Treasury rose from 1.84% to 1.95% as its price correspondingly fell.
The increasing prospect that the Federal Reserve’s (Fed’s) path toward higher interest rates will be gentle, as well as continued merger-and-acquisition (M&A) activity, have helped stocks. However, U.S. investors are still facing soft earnings growth and expensive valuations. While we certainly would not abandon U.S. stocks, we would suggest tilting toward sectors and geographies offering relative value. In particular, we believe investors should consider Asian equities and large, integrated oil companies, which are rallying despite the volatility in oil prices.
The Fed and M&A Trump Soft Earnings
The U.S. earnings season got off to a shaky start last week with a sell-off in Alcoa. While the company beat estimates, its share price fell on news of a glut of capacity in the aluminum industry.
However, stocks benefited from soothing comments from New York Fed President William Dudley, who suggested that the pace of interest rate increases is likely to be “shallow.” Diminished Fed fears have helped to push short-term interest rates back down. Last week, the two-year Treasury note traded below 0.50% for the first time since early February. While yields bounced off of those levels and ended the week at around 0.55, two-year yields are still 20 basis points (0.20%) below their March peak.
As for longer-term bonds, despite some increase, the yield on the 10-year Treasury is still 25 basis points (0.25%) below where it started the year. As discussed in previous commentaries, foreign buying is helping to suppress long-term rates. In February, for example, Japanese investors bought their largest amount of Treasuries in seven months.
One positive side effect of the extraordinary low interest rates is a continuation, even acceleration, in merger activity. Last week Federal Express agreed to buy Dutch carrier TNT for $4.8 billion, and Royal Dutch Shell offered to buy BG Group for approximately $70 billion.