Russ Koesterich, BlackRock’s Global Chief Investment Strategist.
Stocks slip as oil till slides
Despite a rebound on Friday, equities continued their early-year slide last week. The Dow Jones Industrial Average fell 1.27% to close at 17,511, the S&P 500 Index was down 1.22% to 2,019, and the Nasdaq Composite Index lost 1.48% to end the week at 4,634. Meanwhile, the yield on the 10-year Treasury fell from 1.97% to 1.83%, as its price correspondingly rose.
Behind the ongoing skid in stocks were fears over global growth, a poor economic number in the US and an uneven start to the fourth-quarter earnings season. Interestingly, US stocks are trailing other markets year-to-date, despite the relative economic strength of the United States. We attribute this to diverging central bank policies––and the fact that US equities are currently one of the most expensive markets in the world.
A number of factors combined to push stocks lower last week. First, US stocks were hurt by a disappointing retail sales report that showed sales fell by 0.9% from the prior month. Sales were lower even after adjusting for lower gasoline prices. Adding to the gloom, the US earnings season has gotten off to an uneven start, particularly for the banks. JP Morgan started the trend, followed by Citigroup and Bank of America reporting the worst combined trading revenue since 2011.
In addition, investors are still nervous as to what the plunge in commodities prices suggests about the global economy. Oil prices slid further last week, though they rebounded by week’s end. And now oil is not the only commodity market in which prices are reeling. Copper prices tumbled last week and are now at their lowest level since 2009. This is particularly troubling given that copper is one of the more economically sensitive commodities, suggesting that overall global growth remains sluggish. It should be noted, however, that some of the plunge in copper, as is the case with oil, can be attributed to excess supply.
With growth concerns driving a “risk-off trade,” it should come as no surprise that bond yields continue to collapse (and their prices rise). U.S. 30-year bond yields hit a record low of 2.40%. Beyond risk aversion, part of the rise in price and drop in yield is a function of falling inflation expectations. Even in the U.S., where inflation remains positive, inflation expectations are hitting multi-year lows, with the 10-year figure now below 1.60%, the lowest level since 2010.
US stocks no longer in the lead
While the concerns around slowing global growth have been with us for a few months now, the impact on stocks has changed. Unlike the past several years, U.S. shares are now performing worse than the rest of the world. Year-to-date, the S&P 500 Index is down around 2%, underperforming the rest of the world (as measured by the MSCI All Country World Index-ex U.S.).
The problem is simply that both expectations and valuations are particularly high for US stocks. US. economic fundamentals appear solid, but based on the price-to-book measure, U.S. equities are trading at a premium of 60% and 80% versus other developed and emerging markets, respectively. The relative size of the premium makes the US market vulnerable to any disappointment.
All of this underscores one of the basics of investing: Be diversified, and that means casting your net outside the US as well. This is especially important today given that many international economies, although facing considerable obstacles, are likely to benefit from one major tailwind: central bank accommodation.
Unlike the Federal Reserve, most of the major central banks in the world will be easing rather than tightening monetary conditions in 2015. This week, the European Central Bank is expected to initiate its own version of quantitative easing, expanding its asset purchase program to include sovereign debt. Even central banks in emerging markets are now in an easing mode. Last week, the Reserve Bank of India cut its benchmark interest rate.
The bottom line: US equities can move higher in 2015, but as we’ve already seen, the path is likely to be accompanied by much more volatility. In addition, international markets may benefit from less challenged valuations and the tailwind of central bank accommodation. We would not abandon US equities, but this is a good time for investors to ensure that their portfolios are sufficiently diversified outside the US.