A tipping point for TIPS?

By Russ Koesterich, BlackRock’s Global Chief Investment Strategist

Stocks show little movement
US stocks were essentially flat in a holiday-shortened week, while long-term bond yields slipped. The tech-heavy Nasdaq Composite Index fared the best, gaining 0.45% to close the week at 5,127, while the S&P 500 Index inched up 0.04% to 2,090 and the Dow Jones Industrial Average slipped 0.14% to 17,798.

Meanwhile, the yield on the 10-year Treasury fell from 2.26% to 2.22%, as its price rose.

Both stocks and bonds are feeling the brunt of mixed economic data, which has inhibited earnings gains for stocks and is also one of the factors keeping long-term yields contained. The latter is somewhat surprising given the growing likelihood that the Federal Reserve (Fed) will start to nudge short-term rates higher in December.

We believe long-term yields are likely to remain low for some time, and within our bond portfolio prefer Treasury Inflation Protected Securities (TIPS). These offer some hedge against what we view as unrealistically low inflation expectations.

Third-quarter earnings report card is in
With the third-quarter earnings season coming to an end, it is now clear that company earnings are not strong enough to push stocks substantially higher. Quarterly earnings growth was down 3.3% year-over-year, while revenue growth contracted by 4.4%. Part of the problem: After years of levitating at record-high levels, profit margins are coming under pressure.

Still, stocks have managed to climb back in recent weeks to within a few percentage points of their all-time high thanks to multiple expansion (in other words, investors willing to pay more per dollar of earnings). At nearly 19 times trailing earnings, the S&P 500 is now trading in the top decile of its 10-year valuation range. But despite support from multiple expansion, this year has not provided the necessary earnings growth to propel stocks meaningfully higher.

More volatility and gains in unexpected places
Meanwhile, volatile stock markets outside the US, namely in emerging markets (EMs), offer little solace for weary investors. Last Friday, Chinese A-Shares were down 5.5%, their biggest loss since late August.

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