Market Update

• Equities lower after Monday rally. Stocks are down in early trading, a day removed from a broad advance in the major averages. WT crude oil is adding to yesterday’s more than 3% climb that boosted the energy sector to a 1.6% gain. Technology was also a big winner on the day, led by Berkshire Hathaway’s disclosure of a more than $1 billion position in Apple. Overnight, Asian equities finished mixed, with the Nikkei closing up 1.1% and the Shanghai Composite moving slightly lower; in afternoon trading, European markets are pulling back after hitting two-week highs earlier in the session. COMEX gold, Treasuries, and the dollar are all holding steady.

Macro View

• Yield curve flattens to late 2007 level. A 0.08% decline in longer-dated Treasury yields (10- and 30-year) coupled with a slight rise in the 2-year Treasury yield, pushed theyield curve to its flattest level since 2007, just below the lows reached in March of this year. Despite a solid retail sales figure, weak retail earnings and a miss in jobless claims were drivers for reduced growth expectations, which pushed longer yields lower.
• Strong overseas demand for Treasuries evident in auction data. Despite Treasury yields at the bottom of their recent trading ranges, 3- and 10-year Treasury auctions received strong demand last week. The 30-year auction, although slightly weaker on an overall demand basis, witnessed very strong demand from foreign investors (indirect bidders), who took down an above-average 60% of the offering. Foreign demand for Treasuries remains strong in light of lower developed yields abroad and received an additional boost from Asian-based investors returning from the Golden Week holiday.
• The opportunity in mortgage-backed securities (MBS).Although MBS valuations are only average, a sluggish start to 2016 and scenario analysis show the sector may add value in a continuation of the range-bound trading environment that has characterized high-quality bonds. MBS may offer benefits in a flat to rising rate environment. We discuss this in more detail in this week’sBond Market Perspectives, due out later today.
• Oil gives high-yield a helping hand…again. Although it was a down week for equities, high-yield (represented by the Barclays U.S. High Yield Index) returned 0.5% last week and outperformed the Barclays Aggregate, despite the headwind of investor outflows. A 3% rise in oil prices, which continued Monday and powered high-yield bond prices again, helped further defuse default fears and offset poor sentiment from the stock market declines. Flow data indicate that investors are moving up in quality from high-yield to investment-grade corporates, but flows do not necessarily dictate performance. Investment-grade corporate funds received their 10th straight week of inflows with $1.1B in inflows last week, following $2.1B the week prior. High-yield flows were nearly opposite, with a $1.9B outflow last week and $1.8B the week prior, per Lipper data.
• Fed rate hike expectations roughly unchanged last week. A strong retail sales report and hawkish comments from Boston Federal Reserve Bank (Fed) President Eric Rosengren and Kansas City Fed President Esther George helped keep short-term Treasury yields anchored, despite a rally in intermediate- to long-term issues. Rosengren’s comments were more noteworthy as he is a dovish-leaning Fed voter. He said that based on market pricing, the market was being overly cynical about the fundamental strength of the U.S. economy. Market-implied rate hike expectations remain very benign; one Fed rate hike by the end of 2016 is priced in at a 72% probability, and the first rate hike isn’t fully priced in until the April 2017 meeting.
• Municipal bonds: rising supply but demand insatiable.The forward 30-day calendar of municipal bond issuance increased again to just over $17 billion as of yesterday, its highest level since December 2014. However, demand continues to be strong with municipal bond mutual funds recording another $1B+ in inflows–the 19th consecutive week of inflows for the asset class (according to Lipper). Strong demand coupled with Treasury strength pushed the average municipal AAA 30-year yield to a new all-time low of 2.44% yesterday. Although strong demand remains a positive, rising supply and a traditionally difficult month of June present a near-term risk for municipals, although a modest one at that.
• April CPI not enough to convince the Fed to raise rates in June. Led by a 3.4% month-over-month increase in energy prices, the Consumer Price Index (CPI) posted a stronger than expected 0.4% month-over-month increase in April and was up 1.1% from a year ago. CPI excluding food and energy (core CPI) rose 0.2% month over month and 2.1% from a year ago. Beneath the surface, CPI for services (two-thirds of CPI) rose 2.7% year over year, right in the middle of its recent range. CPI for commodities (one-third of CPI) fell 1.4% year over year; but if oil and gasoline prices stay in their recent range, CPI for commodities will turn positive in the second half of 2016 and push overall CPI close to 2%.
• Bounce off the 50-day. The S&P 500 bounced back nearly 1% yesterday, once again finding support near its 50-day moving average. This comes on the heels of dropping close to 1% in two of the previous three days. In fact, in four of the past five days, the S&P 500 has moved at least 0.8% (up or down). We haven’t seen volatility like that since the mid-February lows. Technically, the S&P 500 is potentially forming a bearish chart pattern, and it is sitting on a big level of support currently. Today on the LPL Research blog we will take a closer look at this chart pattern.

Monitoring the Week Ahead

Tuesday

• CPI (Apr)
• Japan: GDP (Q1)
• Russia: GDP (Q1)

Wednesday

• FOMC Minutes
• UK: Unemployment Rate (Mar)

Thursday

• Philadelphia Fed Mfg. Index (May)
• Leading Indicators (Apr)
• G-7 Finance Ministers Meeting in Japan
• Eurozone: Minutes of the April ECB Policy Meeting Released
• Indonesia: Central Bank Meeting (No Change Expected)

Friday

• Existing Home Sales (Apr)

Saturday

• Japan: Imports and Exports (Apr)

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.

This research material has been prepared by LPL Financial LLC.

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