A Third Straight Strong Week
The large-cap stock benchmarks gained more than one percent for the third straight week and established a series of new highs last week as traders reacted to encouraging developments overseas and a positive start to earnings season. The smaller-cap benchmarks and the tech-heavy Nasdaq gained too and pushed into positive YTD territory but remained below the records established in 2015. The small-cap Russell 2000, which is typically more volatile, saw the biggest gain for the week.
Stocks marched higher from the start of last week's trading as a good start to the second-quarter earnings reporting season boosted sentiment. Aluminum giant Alcoa, which is typically the first major company to release quarterly earnings, surprised investors by reporting a smaller-than-expected decline in quarterly profits, helped by strength in the commercial aerospace and auto markets. More good early news on earnings came Thursday, when banking giant JP Morgan Chase beat expectations, thanks largely to cost reductions, although it also saw an overall decline from the same quarter a year ago. Still, data and analytics firm FactSet currently expects overall earnings for the S&P 500 to decline 5.5 percent year-over-year in the second quarter, which would mark the fifth quarterly drop in a row -- the longest such stretch since the financial crisis of 2008-2009.
Falling earnings have come even against the backdrop of continued U.S. economic growth, and much of last week's economic data was upbeat. Retail sales rose 0.6 percent in June, much above expectations. Industrial production for the month of June also beat expectations and rose 0.6 percent, thanks primarily to increases in the output of motor vehicles and utilities. Producer prices saw a substantial gain as well, although consumer prices rose more moderately. Rising wages have been partly responsible for compressed earnings margins.
Prices of U.S. Treasuries fell and thus yields rose steadily throughout last week as equity markets march upwards and positive economic data releases spurred selling in the Treasury market. The Treasury's 30-year bond auction saw robust demand, however, which was surprising considering a weaker 10-year note offering earlier in the week. This news highlights the continued demand for long-term security, even in the face of a risk asset rally and generally positive economic data.
Investment-grade corporate bonds generated strong demand, especially from non-U.S. investors, across all parts of the capital structure and ratings spectrum as the search (reach) for yield continued. The relatively light new issue calendar as the earnings reporting season got underway helped to create a favorable technical backdrop and led to a more active secondary market. High yield bonds advanced amid strong demand and limited new supply. Notably, high yield ETFs saw the largest daily inflows on record.
European equities rallied as the markets grappled with the lasting effects of the June 23rd Brexit vote that prompted stocks there to plummet. Pan-European benchmark Euro Stoxx 600 logged about a 3 percent gain, but its climb was diminished on Friday following the major terrorist attack in Nice, France. Travel-related stocks were among the biggest losers on Friday. For the week, European equities were within striking distance of where they stood before Brexit.
Prime Minister Shinzo Abe's LIberal Democratic Party and its allies won a two-thirds majority in Japan's upper house elections on Sunday. Abe now has a parliamentary supermajority, enough support to push through constitutional reform and his economic agenda. The Nikkei 225 went vertical and posted five consecutive daily gains, advancing 9.2 percent. Nevertheless, for the year-to-date, the Nikeei 225 is still down more than 13 percent, the large-cap TOPIX 100 is off more than 15 percent, and the TOPIX Small Index is roughly 13 percent lower.
China's currency continued to hover near six-year lows last week after the People's Bank of China guided the yuan sharply lower in response to the currency turmoil sparked by the June 23rd Brexit vote. The yuan weakened 2.5 percent against its reference basket of currencies in June in its biggest-ever monthly move. A weaker yuan helps Chinese exporters but it hurts the competitiveness of firms outside China, increases downward pressure on other emerging markets currencies, and worsens deflationary pressures globally. Most traders have fixated on China's slowing economy, but a sudden yuan revaluation could have more severe consequences for many market participants.
Chart of the Week
The following recent articles are well worth your time.
Karma and Dogma (Tom Brakke)
Misconceptions About Diversification (Ben Carlson)
Ten Big Ideas We Believe In (Josh Brown)
Out of whack: Why buying the Treasury is actually riskier than the stock markets (The Washington Post)
A rational response to a seemingly irrational world (Tadas Viskanta)
1945-2016: Here's Basically What Happened (Morgan Housel)
Book of the Week
Expected Returns: An Investor's Guide to Harvesting Market Rewards, by Antti Ilmanen, with a foreward by Cliff Asness, is a comprehensive reference guide that delivers an important toolkit for advisors who want to learn what sorts of investment performance to forecast and expect at different times and in different market conditions, a process that is crucial for making asset allocation decisions. Expected returns of major asset classes, investment strategies, and the effects of underlying risk factors such as growth, inflation, liquidity, and different risk perspectives, are also explained. Judging expected returns requires balancing historical returns with both theoretical considerations and current market conditions. Expected Returns provides extensive empirical evidence, surveys of risk-based and behavioral theories, and practical insights.
Fact of the Week
College degree holders are now 36 percent of the workforce as opposed to workers with a high school diploma (or less) who are now just 34 percent.
Quote of the Week
"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."
-Benjamin Graham (The Intelligent Investor)
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