Ameriprise Financial : U.S. Stocks Boosted as Bond Yields Hit Record Lows

The S&P 500 added another 1.3 percent on top of the 3.2 percent gain of the previous week to erase all of the lost value following the Brexit vote and move within a fraction of its all-time high. The index is now 4.2 percent higher on the year, and up more than 16 percent from its February low. Among the ten major market sectors, only energy stocks suffered losses on the week, as the price of crude fell $3.58 a barrel, or 7.3 percent. Especially noteworthy was the strength in industrials, materials, and financials to close out the week, sectors that had been among the weakest following the UK vote.

Also contributing to the rally in stocks was the ongoing decline in global bond yields. The persistent search for yield and safety, in combination with central bank buying, is pushing yields to record lows, supporting equity valuations and making stocks look attractive in comparison, and creating an unprecedented condition.

As Bloomberg points out, U.S. stocks and government bonds have never come this close to simultaneously ending a trading session at their respective record highs. The ten-year note ended the week at a yield of 1.36 percent, after dipping as low as 1.32 percent earlier in the week. By comparison, just prior to the Brexit vote its yield was 1.75 percent. The German ten-year is now trading at -0.19 percent, down from 0.09 percent prior to the vote, and the Japanese ten-year is yielding -0.29 percent, down from -0.15. The Barclays U.S. Government Bond index has delivered a total return of 6.1 percent so far this year. The long maturity component of the index has climbed by an impressive 19 percent, as the yield on the 30 year Treasury has fallen from 3.01 percent at the start of the year to a record low of 2.10 on Friday.

Stocks in Europe did not enjoy the same success as those in the U.S. The EuroStoxx 50 index of Eurozone equities fell 1.6 percent on the week as measured in euros, and fell 2.3 percent in dollars. Since the vote, the index is down 6.6 percent in euros and 9.0 percent in dollars. The domestically focused UK FTSE 250 index fell 1.7 percent on the week as measured in pounds and 4.1 percent in dollars, as the currency slid another 2.4 percent on the week, and has now fallen 13 percent against the dollar since the vote. Over that same interim, the index is lower by 18 percent in dollar terms.

In one encouraging sign, both indices did manage to end the week on an upswing. The EuroStoxx 50 index rose more than 2.0 percent on Friday in dollars, while the FTSE 250 climbed by 3.2 percent over the final two days of the week. In both cases, bank stocks were notably strong, and in the UK homebuilders were as well. The more foreign revenue dependent FTSE 100 index climbed 0.2 percent in pounds, and is now higher by 4.0 percent since the vote. In dollar terms, however, it fell 2.2 percent last week and is lower by 9.0 percent since the vote.

The late week strength in European bank stocks was apparently attributable to optimism that Italy and the EU will be able to reach an agreement on how to accomplish a bailout of its banking system, which is said to need a capital injection of approximately $40 billion. EU rules now require shareholders and creditors to accept losses before taxpayer money can be used, but in Italy bank debt is owned by small investors to a large extent, making a so-called 'bail-in' both economically and politically unattractive.

In the U.S., the June jobs report suggested that the anemic May report may, indeed, have been an aberration. After creating just a revised 11,000 new jobs in May, the lowest in six years, the economy rebounded with a total of 287,000 new jobs in June, including the reclaimed striking Verizon workers. The report was welcome news, especially coming on the heels of the strongest service sector reading since last November, reported earlier in the week. The rolling average of monthly new job creation has slowed, but that is to be expected with unemployment already quite low. And despite the renewed pace of job creation, the unemployment rate did rise, to 4.9 percent from 4.7, as the participation rate climbed slightly.

The minutes from the Federal Reserve's meeting in June, released on Wednesday, were rendered less impactful since the meeting took place before the Brexit vote. But even the strong service sector and labor market reports this week failed to meaningfully increase the lowered rate hike expectations in place since the vote. At the start of the week the odds of a rate hike in December were just 12 percent. At the end of the week they had risen to just 21 percent.

The Brexit vote came toward the end of June, so if there is going to be a domestic economic impact, it certainly would not have been captured in last week's economic reports. As a real-time indicator of investor sentiment, the stock market appears to be exhibiting little anxiety, although it certainly could be rising primarily in response to record low bond yields more than anything else. The economic calendar this week includes more data from June, including retail sales, industrial production, and consumer prices. But the most telling of all may be Friday's preliminary report on consumer sentiment for July. Second quarter earnings season begins this week as well, and in the aggregate earnings are expected to decline by 5.6 percent according to Factset, led once again on the downside by energy. Bank earnings, in particular will be in the early spotlight.

Important Disclosures:
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The Barclays US Government Bond Index is comprised of the US Treasury and US Agency Indices. The index includes US dollar denominated, fixed-rate, nominal US Treasuries and US agency debentures (securities issued by US government owned or government sponsored entities, and debt explicitly guaranteed by the US government).
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list.
The FTSE 250 is a market-weighted index of the250 leading companies traded in Great Britain on the London Stock Exchange.
The FTSE 100 is a market-weighted index of the 100 leading companies traded in Great Britain on the London Stock Exchange.
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