Markets Rebound From Geopolitical Events; Foreigners Increase Treasury Purchases

in Market Commentary by

Market Digest – Week Ending 7/18

While better than expected earnings from the Financials sector started the week on a positive note, gains were erased on Thursday when a Malaysian airliner was shot down over Ukraine and violence in Israel escalated. Investors sought safety in bonds, which were able to hold onto to a slight gain for the week. Despite one of the largest single day drops in months, global stocks proved resilient and quickly rebounded on Friday. Both domestic and foreign equities ended the week in positive territory.

Weekly Returns:

S&P 500: 1,978 (+0.5%)
FTSE All-World ex-US: (+0.8%)
US 10 Year Treasury Yield: 2.48% (-0.04%)
Gold: $1,311 (-2.0%)
USD/EUR: $1.352 (-0.7%)

Major Events:   

  • Monday – Citigroup kicked off the week with a strong earnings report, driving Financials and US stocks higher for the day.
  • Tuesday – Fed Chairwoman Janet Yellen indicated rate hikes could be sooner than expected if the labor market notched further gains.
  • Wednesday – A report from the US Department of Treasury showed stronger demand for Treasuries amongst foreign nations, namely China.
  • Thursday – A Malaysian Airlines flight was shot down over Ukraine by suspected pro-Russian separatists. There were 283 passengers and 15 crew members on board. Global stocks fell.
  • Thursday – Israel initiated a ground offensive in the Gaza Strip after repeated aerial assaults.
  • Friday – AbbVie agreed to buy UK drug maker Shire for $54 billion. Upon approval, it will move its headquarters abroad.

Our take:

Many investors have avoided US bonds like the plague in recent years, betting against a sharp rise interest rates. But this large spike has yet to materialize, despite an improving US economy and Federal Reserve winding down monthly bond purchases. So far this year, the 10-year US Treasury rate has fallen from 3.0% in December to almost 2.5% in July. In other words, those betting against US bonds were wrong. Again. So what gives? Shouldn’t rates be moving upward? A report released Wednesday by the Department of Treasury highlighted one of the primary drivers of lower rates: foreign demand for US bonds.

As of May, official foreign holdings of US Treasuries totaled $4.09 trillion, which is up from $4.05 trillion in December. The increase was driven by stronger demand for intermediate and longer-term bonds, as foreign nations decreased their holdings of short-term US debt. Once again, China remained the top purchaser, followed closely by Japan.

Will this trend continue? It’s certainly possible. While China is attempting to transition to a consumption-based economy, it is still heavily reliant on exports. In order to sustain growth, it must ensure these exports remain competitive. It does this by purchasing US Treasuries, which in turn weaken its currency and make its products more attractive abroad. So it really comes down to how much additional growth the government is willing to sacrifice as it transitions its economy. Our guess? not very much. As for other nations, demand could continue simply in pursuit of higher yields. US rates remain attractive, particularly compared to Japan.

All of this underscores our opinion that bonds remain an important part of well-diversified portfolios. Certainly rates could rise, but as recent years have demonstrated, no one really knows when. There are countless factors, some known and some unknown, that could keep rates low for an extended period. And when all is said and done, it highly likely bonds will produce a better return than cash over time. So be careful if you’re sitting on the sidelines.

 

Photo Credit: Israel Defense Forces

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Brendan Erne, CFA
Brendan Erne serves as the Portfolio Management Team Leader with Personal Capital Advisors. He has over 15 years of industry experience, spanning almost all levels of the investment process, including several years at Fisher Investments as an equity analyst covering the Technology and Telecommunications sectors. He also co-managed a large cap growth portfolio and co-authored Fisher Investments on Technology, published by John Wiley & Sons. Brendan is a CFA charterholder.
Brendan Erne, CFA

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