U.S. stocks are rallying. But so are bonds! Increasing stock prices signal investor optimism about risk assets, but compressed bond yields reflect a rush to ‘safety’– both of these are happening at the same time. So, are investors confused? Or, is there more to this seeming paradox?
Is the Reflation Euphoria Losing its Steam?
The demand for fixed-income has been pushing down the U.S. 10-year Treasury yield in recent weeks, with it hitting the year’s lowest at 2.15% on June 2. This is a major cooling off of the yield climb we saw in the weeks immediately following Donald Trump’s election. Trump’s pro-growth promises to supercharge the economy sent people’s expectations on fiscal stimulus and inflation racing, and led to a flight from Treasuries to equities.
But to get promises fulfilled into actual implementation, it takes a legislative rigmarole that’s rarely super-smooth. This time does not look any different – a reality that has started to kick in fast, and is reining in some of the post-election euphoria.
Parts of Trump’s proposed ‘reflation’ policies – including tax overhaul and infrastructure spending plans – are still mired in uncertainties. Lack of details on Trump’s tax cut proposal and funding sources for the trillion-dollar infrastructure plan are raising questions on the timing and extent of the plans’ implementation. These grey areas are probably causing investors to hold their horses on inflation and growth, thereby pushing a substantial capital towards the “safety” of Treasuries for now.
Are Equity Markets Telling a Different Tale?
In a seeming conundrum of sorts, bonds’ decreasing yields are going hand in hand with equities climb. The S&P 500 has rallied close to +9% since the beginning of 2017. This comes on the back of Q4 2016’s record-high year-over-year earnings growth (+7.4%) for S&P 500, and even better figures for Q1 2017 (at more than +13%, with most of the companies in the index already reported). Clearly, a large group of investors are looking past ‘noisy’ headlines and/or policy uncertainties to focus on corporate fundamentals as the guiding factor for equity market prospects.
What’s Behind the Double Rally – Divided Groups or Balancing Strategies?
There could be two divided investment sentiments that are driving prices of stocks and government bonds in the same direction – one placing corporate earnings ahead of policy uncertainties and the other doing the opposite.
The double rally in equity and Treasuries could also be reflecting a hedging strategy: fear of overstretched valuations in equities could lead to some portfolio rebalancing towards bonds, while Treasuries’ collapsing yields are possibly raising attractiveness of equity returns.
Bottom Line for Investors
At present, the U.S. markets seem to be in a rare tug-of-war: while policy uncertainties are apparently bidding up bond prices, corporate fundamentals and higher returns are keeping equities buoyant.
Do not let this confuse you! Stay the course with your long-term investment strategy, and don’t jump the gun on speculations. Instead, follow the fundamentals – the most important deciding factor of assets’ long-term potential. At Zacks Investment Management, we keep our clients up-to-date on every development that affects the fundamentals, and guide them accordingly. By leveraging unbiased research and in-house tools, we build customized portfolios with regular rebalancing, and help every client achieve an investing discipline suited to their individual goals. If you need help in understanding which investment strategy suits your investing needs, risk tolerance and time horizon, and how to navigate through market surprises, give us a call at 1-888-600-2783.
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