This year, Rusty Vanneman, the Chief Investment Officer at CLS Investments discussed what he sees as elements leading the market right now, and what he’s keeping an eye on for the second half. Rusty and I also had a moment to discuss what he sees as the biggest surprises for the year so far.
For the month of May, the S&P 500 rose +2.35%, the MSCI EAFE (developed international) gained +1.62%, MSCI Emerging Markets (emerging markets) rocketed +3.48%.
Here are the 3 surprises for the year so far:
Lower Bond Yields/Interest Rates
While the big gains in Russia of late may seem surprising, the biggest surprise to most investors is the large drop in interest rates this year. Though investor sentiment was strongly bearish at the beginning of the year, rates have dropped for the bellwether 10-year Treasury by over half of 1%. Yields for the 10-year Treasury were over 3% late last year. In the closing days of the month, they were at 2.4%. (For a frame of reference, yields for 10-year Treasuries were below 1.5% a few summers ago.)
Why have yields fallen? There are at least a handful of contributing reasons: There has been a lack of supply growth in bonds, at least not enough to offset demand. There have been concerns about equity valuations and geopolitical news. Trading volumes in the bond market have been relatively light, which can make the market a bit easier to push around.
While return prospects for bonds are not exciting given the low rates, but we also still appreciate the powerful diversification benefits to owning bonds. Thus, maintaining bond exposure may still be a good idea, while keeping fairly defensive positioning by holding interest rate sensitivity low.
Rising Inflation Expectations
If one knew that bond yields were to drop over half of 1%, and they knew nothing else, one would also typically expect that inflation expectations would drop. That, however, has not been the case this year. Inflation-sensitive assets, such as commodities and Treasury Inflation-Protected Securities (TIPS) are both on fire this year, providing above-average returns. Again, this is interesting, as bond yields have fallen and official inflation data hasn’t exactly spiked higher.
Falling real interest rates (inflation-adjusted interest rates) are often inflationary. In the event of an inflation uptick, commodities usually perform well and TIPs usually beat nominal Treasuries. Due to this development consideration to modest increase in exposure to these asset classes may be necessary for an actively diversified investment portfolio.
Rising Stock Prices
Higher stock market prices at this point in the year wasn’t necessarily a surprise – unless one heard that bond yields had dramatically fallen, that inflation expectations were rising, and that small cap stocks were significantly trailing the broader market. On the last point, a healthy stock market usually has small cap stocks leading the way. An emphasis on high quality may be in order, as higher-quality securities tend to perform better in a choppy, directionless market in addition to a slower-growth environment. This likely includes a lean toward larger companies who have been the leaders throughout this lengthy bull market.
CLS Investments significantly contributed to this market commentary.
The views expressed herein are not meant as investment advice and are subject to change. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.
You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance. Investing in any security involves certain non-diversifiable risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any specific, or diversifiable, risks associated with particular investment styles or strategies.
The S&P 500® Index is an unmanaged composite of 500-large capitalization companies. This index is widely used by professional investors as a performance benchmark for large-cap stocks. The Russell 3000 Index is an unmanaged index considered representative of the U.S. stock market. The index is composed of the 3,000 largest U.S. stocks. The Russell 2000® is an index comprised of the 2,000 smallest companies on the Russell 3000 list and offers investors access to small‐cap companies. It is a widely recognized indicator of small capitalization company performance. The MSCI All-Countries World Index, excluding U.S. (ACWI ex US) is an index considered representative of stock markets of developed and emerging markets, excluding those of the US. The MSCI EAFE International Index is a composite index which tracks performance of international equity securities in 21 developed countries in Europe, Australia, Asia, and the Far East. The iShares MSCI Emerging Markets ETF is an exchange traded fund which seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of publicly traded securities in emerging markets, as represented by the MSCI Emerging Markets Index. The Barclay’s Capital U.S. Aggregate Bond® Index measures the performance of the total United States investment-grade bond market. The Barclay’s Capital 1-3 Month U.S. Treasury Bill® Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than1 month, are rated investment grade, and have $250 million or more of outstanding face value. An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general. You cannot invest directly in an index.
Bonds are a type of debt instrument issued by a government or corporate entity for a defined period of time at a fixed interest rate. The most common risks for bonds are non-diversifiable risks, but bonds may be subject to diversifiable risks including, but are not limited to, call risk, reinvestment risk, and credit risk. High Yield bonds, or junk bonds, will be subject to an even greater degree of these aforementioned risks as well as subject to credit risk and business risk.
Investing in commodities refers to investing in trade goods used in commerce. When traded on an exchange, all commodities must meet a minimum acceptable grade called the Basis Grade. Diversifiable risks may include, but are not limited to business risk, capital risk, and regulatory risk. Treasury Securities are securities issued by the U.S. Government. Generally issued to fund its operations and backed by the full faith and credit of the U.S. Government, treasury securities are considered extremely low risk investments and may include: Treasury Bills (T-Bills), Treasury Notes, Treasury Bonds (T-Bonds), or Treasury Inflation Protected Securities (TIPS). The return on treasury investments is measured by the Treasury Yield. The primary diversifiable risk is opportunity risk
International investing involves additional risk, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification.
