Stocks Rally in Anticipation of Good News
Global stocks continue to gain ground compared to bonds (chart, below). Headlines on trade, the budget, and Brexit are recent market movers. The resolution of these issues, yet unknown, could shape how the rest of the year plays out. A bullish scenario envisions growth returning to the globe as nations reach compromises. An intensification of these issues, or if left unresolved, could further darken the outlook.
Slowing growth in China, softening sales of homes and automobiles, weak retail sales, and a sharp decline in European industrial production are the latest signs of stress. The adoption of a “wait and see” approach to rate hikes by the Federal Reserve and European Central Bank are in response to weakness. Analysts have slashed earnings forecasts, too. According to FactSet, S&P 500 earnings are expected to decline 2.2% in the first quarter.
Neither is the bond market completely buying the positive story the stock market is telling. On Friday, the Treasury yield curve flattened to the lowest level since 2006, just prior to the last recession. The spread between the yield on 10-year and 3-month U.S. Treasury bonds fell to just 0.24%. This spread, which ranged between 1.5% to 2.5% from 2009 to 2016, is watched as an indicator of potential recession. A very flat or negative spread is often followed by weak growth or recession.
On the plus side, corporate bond spreads over Treasuries stopped widening in recent days. A rising yield on corporate bonds compared to Treasuries could mean investors are more concerned about corporate finances. A year ago, investors required about 1.3% higher yields than long-term Treasuries to own long-term Baa-rated corporate paper. After rising to 2.4% in early January, the premium is back to about 2.1% — a step in the right direction.
We are not going to guess how trade issues will resolve. The next few weeks should be very revealing, however, as the China trade and Brexit negotiations progress. To date, these issues are casting a cloud over the outlook for the global economy, weighing on sentiment, and dampening demand and investment.
Kevin Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
Suzanne Ashley, Analyst
WCA Fundamental Conditions Barometer Description: We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.
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