Market Update

• Stocks open lower despite generally upbeat earnings. U.S. markets opened lower this morning as investors sifted through a flood of earnings reports. Of note, Goldman Sachs and IBM beat earnings estimates while Netflix guidance disappointed. The S&P 500 traded in a narrow range on Monday before closing 0.2% higher on strength in the technology and materials sectors. Overseas, European stocks are trading lower on a worse than expected German ZEW economic sentiment report, while the Nikkei gained 1.4% and the Shanghai Compositedropped 0.2% overnight. Meanwhile, COMEX gold and WTI crude oil are near flat, while the 10-year Treasury yieldhas slipped several basis points.

Macro View

• Treasury yields retrace 45-70% of post-Brexit move lower. Expectations of stimulus in Japan, reduced Brexit uncertainty, and Friday’s strong retail sales report all worked to pressure Treasury yields higher through Monday, July 18. The 10-year German bund closed the week in positive territory for the first time since late June. Anticipation of more rate cuts by central banks across Europe also boosted growth expectations globally. Trading action in high-quality bonds remains weak amid a lack of top tier data.

• Growth expectations, not inflation, driver of yields.Better economic growth expectations were the primary driver of bond yields last week as inflation expectations moved only marginally higher by 0.05% and remain benign at 1.5%. The real, or inflation-adjusted, yield of the 10-year Treasury increased by 0.23%, indicating Treasury yields reflected an overly pessimistic view.

• Fed rate hike expectations creep higher. Federal Reserve Bank (Fed) rate hike expectations moved higher again but remain very benign. Futures pricing indicates a 42% chance of a hike by year-end; a rate hike isn’t fully priced in until September 2017. Long-term futures suggest a low 1.5% overnight rate, five years from now.

• Economically sensitive bond sectors weather rising yields. High-yield bonds, emerging markets debt, investment-grade corporate bonds, and bank loans all benefited from better market growth expectations, and in some cases, showed outright price gains despite high-quality bond price declines. Of interest, high yield bonds showed for a second week they can improve without the help of oil prices. The average high-yield bond spreadclosed at 5.4% as of July 18.

• Moody’s global default rate rises to 4.5% from 4.0% during second quarter of 2016. In the U.S., the default rate increased to 5.1% as energy and mining companies continue to lead defaults. Moody’s forecasts defaults will continue rising over the remainder of 2016 to 4.9% globally before decelerating in 2017 to 4.2%. The forecasted change reflects that the bulk of energy-related defaults have already occurred.

• June and July municipal price trends flip-flop thus far in 2016. July, historically one of the stronger months formunicipal bond performance, has witnessed price declines in sympathy with high-quality taxable counterparts. TheBarclays Municipal Bond Index is down 0.2% month to date through July 18. July weakness may be payback for a robust 1.6% return in June, the weakest month of the year in the municipal bond market over the past 10 years. On a positive note, municipal weakness was less pronounced than Treasuries, causing 10- and 30-year AAA municipal-to-Treasury ratios to move lower (valuations richen), closing Monday at 94% and 100%, respectively.

• Another set of solid housing starts and building permit data in June. At 1.189 million, housing starts exceeded expectations (1.165 million) in June and accelerated from the May reading of 1.135 million. Single family starts–the most economically sensitive part of this data set–were up 13% from a year ago. Permits, which tend to be more of a leading indicator of future housing activity, also exceeded expectations in June and accelerated from May. Single family permits were up 5% from a year ago. Supported by low interest rates, a solid labor market, a pickup in household formation, modest home price gains in-line with incomes, and sound lending practices relative to the 2002-2007 housing boom, we continue to expect that housing will contribute positively to gross domestic product (GDP)growth in 2016 (as it has since 2011) via the residential investment category. However, at only 5% of GDP, housing has only a limited direct impact.

• Early post-Brexit data. The ZEW investor confidence survey for both Germany and the European Union was released this morning. Expectations for both areas were negative, much lower than expected and lower than previous readings. This is one of the first post-Brexit data points from Europe. Important to note, these are surveys of expectations. For the most part, we are still months, if not years, away from any direct economic and financial impact of the Brexit vote.

• More new highs. The S&P 500 managed a slight gain to close at a new all-time high for the fifth time in the past six days. It was a solid day of outperformance for tech and materials, while telecom lagged. Given tech has lagged much of this year–and it is a huge component of the S&P 500–should this important group finally start to lead, it could be a good sign. Turning to the Dow, it has made a new all-time high for five consecutive days and been green for seven straight days. The last three times it was up seven days in a row (December 2014, October 2015, and March 2016), it dropped on day eight.

• Where does the bounce in 2016 rank? The S&P 500 is 19.7% above the February lows and is currently up 6% for the year. This bounce has no doubt been impressive, but going back in history, it may not be so rare. In fact, going back 25 years, the S&P 500 finished the year more than 20% above its calendar year lows in 12 of those times. Also during the past 25 years, the average year has closed 21.6% above the calendar year lows, with the median year up 18.5%. In other words, this bounce off the lows would rank more average than anything.

Monitoring the Week Ahead

Tuesday

• Housing Starts and Building Permits (Jun)
• Eurozone: ECB’s Bank Lending Survey (Q3)
• Germany: ZEW (Jul)
• IMF Releases Summer Macroeconomic Forecasts

Wednesday

• Eurozone: Consumer Confidence (Jul)

Thursday

• Initial Claims (7/16)
• Philadelphia Fed Mfg. Index (Jul)
• Eurozone: European Central Bank Meeting (No Change Expected)

Friday

• Markit PMI Mfg. (Jul)
• Eurozone: Markit Mfg. PMI (Jul)

Saturday

• G-20 Finance Ministers Meeting in China

Sunday

• Japan: Imports and Exports (Jun)

Click Here for our detailed Weekly Economic Calendar

 

Important Disclosures

Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Stock investing involves risk including loss of principal.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio, as the principal is adjusted semiannually for inflation based on the Consumer Price Index (CPI)—while providing a real rate of return guaranteed by the U.S. government. However, a few things you need to be aware of is that the CPI might not accurately match the general inflation rate; so the principal balance on TIPS may not keep pace with the actual rate of inflation. The real interest yields on TIPS may rise, especially if there is a sharp spike in interest rates. If so, the rate of return on TIPS could lag behind other types of inflation-protected securities, like floating rate notes and T-bills. TIPs do not pay the inflation-adjusted balance until maturity, and the accrued principal on TIPS could decline, if there is deflation.

Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards.

High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.

Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.

Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.

Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

Technical Analysis is a methodology for evaluating securities based on statistics generated by market activity, such as past prices, volume and momentum, and is not intended to be used as the sole mechanism for trading decisions. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns and trends. Technical analysis carries inherent risk, chief amongst which is that past performance is not indicative of future results. Technical Analysis should be used in conjunction with Fundamental Analysis within the decision making process and shall include but not be limited to the following considerations: investment thesis, suitability, expected time horizon, and operational factors, such as trading costs are examples.

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