A Late Rally on Greek News
U.S. stocks and bonds treaded water for most of last week, but equities managed to squeeze out a new high on Friday following news of a tentative deal between Greece and the European Union (EU) finance ministers to extend the Greek bailout for four months. Both the Dow Jones Industrial Average and the S&P 500 Index rose 0.67% to close the week at 18,140 and 2,110, respectively, while the Nasdaq Composite Index climbed 1.27% to 4,955. Meanwhile, the yield on the 10-year Treasury inched up from 2.06% to 2.12% as its price correspondingly fell.
While the major indexes were relatively stable last week, we continue to see several trends below the surface that lead us to maintain our preferences: International over U.S. equities, and within bonds, credit over long-term Treasuries and other rate-sensitive assets.
Reading the Fed Tea Leaves
Prior to Friday afternoon, U.S. stock and bond indexes were generally flat for the week, with little in the way of corporate earnings and on the heels of mixed economic data releases. For example, producer prices fell at a much quicker pace than expected in January, even after stripping out energy prices.
Investors spent much of last week pondering what the Federal Reserve (Fed) will do with respect to raising rates in the coming months. Minutes released from the Jan. 27-28 meeting suggest the Fed is somewhat divided over when to raise rates, given that inflation is low and global risks elevated.
Ambiguity over the pace of monetary tightening reversed some of the recent uptick in short-term yields. However, 10-year U.S. rates remain roughly 45 basis points above their January lows. The shift in the rate environment has had a more noticeable impact on rate-sensitive assets as investors grow more cautious. U.S. utility exchange traded funds experienced significant outflows last week. Finally, gold prices, which are historically sensitive to real interest rates (the interest rate after inflation), have slid as rates have risen, with gold now down 8% from its January peak.
While investors have become more cautious on investments most likely to be affected by higher interest rates, there is a growing comfort with other areas of the bond market. Flows into high yield bonds have surged and as investors have favored the asset class, spreads––the difference between the yield of high yield bond funds and Treasuries––have narrowed by more than 50 basis points over the last few weeks. We still see relative value in this asset class, despite outperforming both nominal Treasuries and Treasury Inflation Protected Securities this year.