July 16 2013 Drop in Interest Rates Fuels Stock Market Rally One of the main issues affecting global financial markets in recent weeks has been the increase in interest rates that has resulted from investor concerns over a potential change in Federal Reserve policy. Last week saw a reversal of that trend. Fed Chairman Ben Bernanke sounded a more dovish tone when he indicated that the Fed was unlikely to hike short-term rates abruptly, which resulted in a notable pullback in US Treasury yields. For the week, Treasury yields declined (as prices correspondingly rose), with the yield on the 10-year Treasury falling from 2.72% to 2.59%. A fall in interest rates, combined with some early indications that corporations were beating very modest expectations for second-quarter earnings, helped spark a sharp rally for stocks. Markets experienced their third straight week of gains, with the Dow Jones Industrial Average advancing 2.2% to 15,464 and the S&P 500 Index climbing 3.0% to 1,680. Both indices again hit new record highs last week as well. For its part, the Nasdaq Composite rose 3.5% to 3,600. Modest Inflation Should Help Keep a Lid on Rates Going forward, expect fixed income markets to remain volatile, but we do not believe that we will see a precipitous drop in prices and overly dramatic advance in yields. For one reason, inflation still remains tame, which means the US Fed is under less pressure to move quickly. Thanks to a strong US dollar, which lowers the cost of foreign imports into the US, US import prices were up only 0.2% in June on a year-over-year basis. Stripping out oil prices (which have been rising recently), overall import prices were actually down 0.5% over the last year. Additionally, last week’s data showed that June’s Producer Price Index (PPI) was reasonably well contained. The headline number did show a spike, but the core number (which excludes volatile energy and food prices) showed just a 1.7% increase, close to the lowest level seen since early 2011. Although several members of the Federal Reserve have clearly indicated that the central bank’s longstanding easing bias presents some risks, without inflationary pressure the Fed is unlikely to quickly shift away from monetary accommodation. A Recipe for Continued Gains in Stocks For equities, the view is that as long as we do not see a significant increase in yields, stock markets can continue to advance, as we saw last week. In addition to the interest rate and inflation environment we described, we would point out that corporate balance sheets remain quite healthy and that stocks appear reasonably priced relative to their own
historical valuations as well as to bonds and cash alternatives. As such, the view is that we are likely to see further equity price increases over the next six to twelve months (although the pace of gains is unlikely to match what we saw in the first half of the year). As investors think about their stock portfolios, we would highlight the case for looking outside the United States and including international stocks in a portfolio. True, Europe remains mired in recession, but overall, international stocks look inexpensive and have already discounted potential bad news. Global Outlook Investors have become nervous recently about the path for US Fed policy and the trajectory of Chinese growth. Growth in the US is subpar by historic standards but, importantly, it is stable, which has emboldened the Fed to talk about removing some of its stimulus. Eurozone growth is more problematic but the relative stability in periphery bonds has been an important offset to a weaker economic backdrop. Regarding China, most investors had thought that an economic slowing would produce a policy response but this view has been re-assessed this year and caused Chinese shares to be quite weak. Investors continue to be cautious regarding the Asian region as a whole for now. Goods’ and wage inflation globally is modest and recent readings for consumer prices in the US and Europe have been weak. Monetary policies remain very loose and this still looks a necessity in several of the major regions. Nonetheless, investors are becoming very sensitive to comments from the Fed that it will ‘taper’ the extent of its policy generosity. Other central banks are generally neutral in their stance. Meanwhile, the ECB has just emphasised that it will keep policy loose for a protracted period of time. It will likely deliver further policy initiatives before this cycle is over. Fed ‘tapering’ commentary has sent US and European bond yields higher by 0.5% to 0.75% in recent weeks, with many again talking of the bond bubble bursting. The view that historically low long-term interest rates will persist in many countries remains as long as central banks sponsor low short-term rates. The recent panicky moves have caused bond markets to be oversold and we expect US and German bond prices to stabilise, and likely move higher, in coming weeks. Bonds The yield on the 10-year US Treasury eased somewhat during last week after the dovish comments from Ben Bernanke. It closed at 2.60%, a fall of 10bps on the week. Core eurozone bonds, in the shape of the German 10-year bund, saw a fall in yield of 17bps to 1.55%. On the periphery, political developments in Portugal were not so positive, though Irish yields remained steady enough after S&P upgraded its outlook for Irish bonds. Overall, the Merrill Lynch over 5 year government bond index closed up 0.5%. Currencies It was the turn of the US dollar to be weaker in the wake of Mr. Bernanke’s comments. The euro held comfortably above the 1.30 level, having closed the previous week at close to 1.28. The euro also gained against sterling, closing at over 0.86.
Commodities Gold enjoyed a very strong week, rising by almost 5% in the wake of Ben Bernanke’s comments on the continuing need for accommodative policy in the US and the related weakening in the dollar.
House View Performance Thomond Asset Management maintains an investment house view on how we feel your funds should be invested with each fund manager. Below we have provided you with the performance of each of these managers on an annualized basis.
Fund Manager 1 Year Zurich 9.02% New Ireland 4.69% Standard Life 9.68% Aviva 8.73% Canada Life 8.05% Friends First 8.05% Irish life 9.32% *Performance provided by Financial Express
3 Year 21.46% 16.51% 23.26% 27.16% 17.18% 16.82% 18.83%
5 Year 34.38% 17.76% 49.48% 41.57% 21.38% 17.80% 37.10%
Note: The performance of the above portfolios may not directly correlate to an individual’s portfolio. Please speak with your financial advisor to understand your specific portfolios performance. Asset allocations between fund managers will differ. Source: Bloomberg, Aviva Investment Mangers, Zurich Investment Managers & Blackrock