Markets react to economic divergence

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Weekly Investment Commentary by Russ Koesterich, BlackRock’s Global Chief Investment Strategist.

Strong Data Propel US Stocks

US stocks generally continued to climb last week on more positive economic data. The Dow Jones Industrial Average rose 0.73% to close the week at 17,958, the S&P 500 Index was up 0.39% to 2,075, while the Nasdaq Composite Index slipped 0.23% to 4,780. Meanwhile, the yield on the 10-year Treasury rose from 2.19% to 2.30%, as its price correspondingly fell.

The US economy continues to exhibit strong momentum, although the same cannot be said for other parts of the world. Looking ahead, investors should expect significant divergences within the global economy. That theme is having, and will continue to have, important implications for financial markets. Among the most notable implications: a stronger dollar, wariness around short-term US bonds, and a preference for US cyclical stocks and emerging markets in Asia.

Impact on Short-Term Bonds and Cyclical Stocks

Last week’s economic data supported the consensus view that the US economy will continue to outpace most other parts of the developed world. November readings on both the ISM Manufacturing and Services indexes were well ahead of expectations. While initial holiday sales figures were disappointing, showing an 11% drop from last year, this was probably more a function of changing consumer habits (in an age of online shopping, lining up at 3 a.m. on a cold November morning may be losing some of its appeal) rather than a sign of weakness.

Most importantly, November’s employment report released on Friday saw new jobs surge by 321,000, the largest single monthly increase since 2012. The three-month moving average is now at nearly 280,000, close to double the level from earlier this year.

Not surprisingly, the steady stream of numbers showing consistent growth is having an impact on the performance of different segments of the market. Within fixed income, short-term bonds are starting to come under renewed pressure. Last week, the yield on the two-year US Treasury rose to over 0.60%, the highest level since the spring of 2011.


In equities, stronger growth is starting to translate into better relative performance for more cyclical stocks. Over the past month, the Dow Jones Transportation Index—also a big beneficiary of lower oil prices—has gained almost 4%, while the Philadelphia Semiconductor Index is up around 8%. At the same time, defensive sectors are starting to trail the broader market, with the Dow Jones Utility Index down nearly 2% over the same timeframe. We would expect this trend to continue in 2015.


Faster Growth Is Not a Global Phenomenon

While the US economy is accelerating, other economies continue to struggle. This was evident last week in a disappointing manufacturing survey from China as well as a drop in Germany’s Purchasing Managers Index, which last month fell into territory consistent with a contraction in the manufacturing sector.


Softer growth in other parts of the world is having the predictable impact of supporting the US dollar. Last week the dollar fell below $1.23 versus the euro, the lowest level since 2012. A tendency toward a strong dollar is another theme we expect to continue in 2015.


Divergence Also an Emerging Markets Theme

As with developed markets, emerging markets are showing increasing divergence. The performance of individual countries is being largely driven by two themes: central bank actions and sensitivity to energy prices.


For example, Chinese equities continue to rally despite—or perhaps because of—weaker economic data. More evidence of economic deceleration has led many investors to expect further stimulus from the People’s Bank of China. This hope pushed Chinese equities up roughly 10% last week to a new three-year high.


Elsewhere, the situation looks very different. After a brief rally based on optimism that re-elected President Dilma Rouseff would put in place a more market-friendly economic team, Brazilian shares are once again slipping as the Brazilian central bank unexpectedly raised short-term rates. Meanwhile, Russia’s economy and currency continue to slide. The ruble is down roughly 40% year-to-date. The currency is collapsing from the combined hit of economic sanctions as well as plunging oil prices and general economic mismanagement.


With all of this as our backdrop, we reach the same conclusion that we have in prior weeks: Emerging markets in Asia that are benefiting from easy money policies and lower oil prices are well worth investor consideration.

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