Tantrum potential at home, opportunity overseas

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By Russ Koesterich, BlackRock’s Global Chief Investment Strategist.

Stocks eke out slight gains

US stocks ended last week essentially flat, although the S&P 500 Index did post another record close on Thursday. For the week, the S&P inched up 0.14% to 2,126, the Nasdaq Composite Index advanced 0.81% to 5,089, while the Dow Jones Industrial Average slipped 0.22% to 18,232. Meanwhile, the yield on the 10-year Treasury rose from 2.15% to 2.21%, as its price correspondingly fell.

We believe US equities can continue to climb and post further gains before the end of the year. However, we also believe the best opportunities may reside outside the United States, which, in fact, has been the case so far this year.

Taper tantrum II ahead?

Mergers-and-acquisitions (M&A) activity continues to support the US stock market. Last week brought the announcement of deals in retail (Ascena Retail Group to acquire Ann Inc., owner of Ann Taylor, among other brands), pharmaceuticals (Endo International to acquire Par Pharmaceutical) and health care (CVS to buy Omnicare).

Paradoxically, another factor boosting stocks has been mixed economic data, which has alleviated concerns over an aggressive Federal Reserve (Fed) rate-hiking regime.

Although stocks have clearly benefited from the Fed’s languid path to an initial rate hike, the market’s luck may not last. A fall rate hike is likely, particularly after April’s consumer inflation report released last week. Core inflation (which excludes food and energy) accelerated on the back of higher medical and rent costs, although the year-over-year drop in energy prices pushed headline inflation further into negative territory. As a result, two-year Treasury yields, the most sensitive to future Fed policy, reversed their recent downtrend and ended Friday at 0.61%, up nearly 10 basis points (0.10%) for the week.

An autumn rate hike by the Fed and the resultant modestly higher rates are unlikely to be a catastrophe for markets. Rates will be rising from a historically low level, the pace of future hikes will be measured and bull markets rarely end with a first rate hike.

Still, liftoff by the Fed would mean that the safety blanket of ultra-accommodative monetary policy starts to be removed. And as the market demonstrated in the spring of 2013, investors’ reaction to losing their safety blanket is roughly the same as most toddlers: A tantrum may, at least temporarily, ensue.

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