Cheering, not fearing, a rate hike?

Russ Koesterich, BlackRock’s Global Chief Investment Strategist

A rally with a twist

Stocks rallied last week, recouping most of the previous week’s losses. The tech-heavy Nasdaq Composite Index led the pack, gaining 3.59% to close the week at 5,104, while the Dow Jones Industrial Average rose 3.35% to 17,823 and the S&P 500 Index climbed 3.26% to 2,089.

Meanwhile, the yield on the 10-year Treasury slipped from 2.28% to 2.26%, as its price rose.

Last week, investors looked past the tragic attacks in Paris and once again focused on central bank policy. The twist is that investors celebrated the potential for more divergence: tightening by the Federal Reserve (Fed) while the European Central Bank (ECB) pursues easing.

Both trends have implications for investor positioning. We would suggest a continued overweight to hedged European equities while in the US adopting a modest tilt toward large- and mega-cap stocks.

Central Bank clues move the markets

Investors now appear to be treating a December rate hike by the Fed as a sign of economic stability rather than something to be feared. As such, investors were cheered by the minutes from the October Fed meeting, which were released last week. Consistent with recent statements, it now appears the Fed views the economy as strong enough to justify an initial rate hike, most likely in December.

Although manufacturing remains weak — more evidence of which came this week in the form of anemic machine sales from Caterpillar, a six-year low in copper prices and a soft report from the Empire State Manufacturing Index — the broader economy is doing reasonably well while inflation and inflation expectations are stabilizing.

With fears over domestic growth waning, investors pushed up stocks and short-term yields, although commodities and credit mostly sat out the rally. Investors continue to demonstrate an appetite for companies perceived as beneficiaries of secular growth trends, notably technology.

Last week, mobile payment maker Square Inc. surged on its first day of trading, counteracting concerns about the IPO price having been marked down from its previous valuation.

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