William Riegel, Chief Investment Officer TIAA Investments
September 9, 2016
Those hoping for the ECB to take action were disappointed. Despite stubbornly low Eurozone inflation, the central bank opted against raising its monthly asset purchase target of €80 billion or extending the program’s duration beyond its current March 2017 end date. Moreover, the ECB left its key interest rates unchanged. The decision to stand pat weighed on Europe’s broad STOXX 600 Index, which lost 1.4% for the week (in local currency terms).
In the U.S., the S&P 500 Index shrugged off some sluggish economic data early in the week to climb within four points of its all-time high before following European stocks lower. The index slumped 2.5% on September 9, its first loss of greater than 1% since Brexit in late June, and about 2.4% for the week. Talk of tightening by a voting Fed official, along with falling oil prices, added to the selling pressure. With the U.S. economy slowing at the margin, the equity market looking stretched, and short-term investor optimism reaching bullish levels, the S&P 500 may slip further in the near term.
Current updates to the week’s market results are available here.
Returns for non-Treasury “spread” sectors were mixed for the holiday-shortened week through September 8. High-yield bonds led the way, bringing their year-to-date return to 14.8%, based on the Barclays index.
Meanwhile, U.S. Treasury markets took their cue from Europe. The yield on the bellwether 10-year note rose from 1.61% on September 8 to 1.67% the next day, leading to a steeper yield curve. (Yield and price move in the opposite direction.)
In terms of fixed-income security selection, some of the riskiest debt, including lower-quality high-yield corporate bonds, have outperformed strongly since Brexit and appear richly valued. In contrast, investment-grade corporate bonds offer relatively attractive valuations. Their supply, though, is likely to approach record-high levels this month and next, temporarily pressuring spreads. We are also mindful of the increasing use of leverage in the corporate bond space. This could lead to credit downgrades if the U.S. economy contracts, a scenario we don’t currently anticipate. Emerging-market debt remains attractive as well despite its robust performance so far this year. This asset class, which is sensitive to dollar strengthening, should benefit from gradual, as opposed to more abrupt, Fed tightening.
Despite the rise in the 10-year Treasury yield, we don’t expect a sustained increase to 2% by year-end given sluggish global growth and low levels of inflation around most of the world. We do, however, believe fixed-income trading activity will snap out of its summer lull. The fall season, especially during an election year, has historically been volatile.
Foreign stock market returns are stated in U.S. dollars unless noted otherwise.
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