US healthier, but not immune to rest of the world

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Russ Koesterich, BlackRock’s Global Chief Investment Strategist comments on the challenges for the US economy in 2015.

A Turbulent Week for Stocks
Stocks and other risky assets experienced particularly violent moves last week. The Dow Jones Industrial Average fell 3.77% to close the week at 17,280, the S&P 500 Index dropped 3.52% to 2,002, while the Nasdaq Composite Index was down 2.65% to 4,653. Meanwhile, the yield on the 10-year Treasury fell from 2.30% to 2.10%, as its price correspondingly rose.

It was not a week for the faint of heart and, for better or for worse, we are likely to see more turbulence ahead. Given uneven global growth and the impending tightening of US monetary conditions, investors can expect more bouts of volatility. Adding to the uncertainty are potential consequences from elections in Japan and Greece.

Strong Growth in the US, But That’s Not Enough
Last week, countervailing forces pulled stocks in opposite directions. On the positive side, a strong November retail sales number offered more evidence suggesting that the US economy is improving. Less positive is the fact that the US is increasingly alone in its resiliency.

Outside the US, we’re seeing several signs of slowing growth: weak import/export data from China, multiple downgrades of global oil demand accompanied by a further plunge in prices, more stringent collateral requirements in China and renewed angst over European politics.

This dichotomy between the US and the rest of the world was starkly represented by the money invested in mutual funds and exchange traded products for the week ended December 10. US ETFs garnered $2.4 billion in assets, while European funds suffered $1.6 billion of outflows.

Still, economic resilience at home does not mean US assets are immune to the global slowdown. The S&P 500 Index traded down to a five-week low and volatility –– as measured by the VIX Index –– rose above the 20 threshold for the first time since October. The VIX was below 12 less than two weeks ago. We’ve also seen a significant sell-off in high yield bonds. This has sent the “spread,” or the difference between the yield for high yield bonds and US Treasuries, to its widest mark since June 2013.

But the biggest losses were once again in the commodity sector, particularly oil. The price of US benchmark WTI crude oil slipped below $60/barrel, the lowest level since July 2009.

Meanwhile, in contrast, safe haven assets rallied. German bund yields fell below 0.70%, 10-year US Treasury yields closed below 2.10% and U.S. tax-exempt bonds experienced a 19th straight week of inflows.

Global Politics Stoke Risk…and Opportunity
The contrasts between the US and the rest of the world are on display on the political stage as well. The year ahead is likely to be one of relative inactivity in US politics. Indeed, the US Congress just barely managed to squeeze a funding bill through and avert another government shutdown. However, before the calendar even turns the page, we’re already seeing global politics re-emerge as a key investment driver. The past week featured two examples: one that we would characterize as a risk and one a potential opportunity.

The risk comes from Europe. Last Monday, Greek Prime Minister Antonis Samaras surprised everyone by moving up the date for a Greek parliamentary vote for a new president. (The first vote takes place on Dec. 17, but the final round does not occur until late in the month.) It is not clear the government can reach the necessary majority to maintain power.

Anxiety over the election and the potential for a new government in Greece less committed to reform is already being felt in asset prices. Not only did Greek assets sink on the news last week, but broader European equities suffered one of their worst weeks in months, reflecting investor concerns that the ramifications would be felt throughout the Eurozone.

While European politics represent a risk, Japan’s may offer an opportunity. Preliminary results from Sunday’s election suggest that the ruling LDP party maintained, and potentially increased its super-majority in Japan’s lower house (The Diet). The strong showing by the LDP party will — in theory — give Prime Minister Shinzo Abe the political clout to push through more pro-growth policies, including trimming the corporate tax to 20%, enacting labor market reform, and deregulating the energy and farming sectors. All of these, in our assessment, would further strengthen the case for Japanese stocks.

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