Investment Insights: Investor anxiety refocuses on rates

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Trader's hands checking smartphone showing stock performance graph that has big spikeStocks tumbled on Tuesday as a handful of stalwart companies reported a negative outlook to their earnings despite a strong positive trend in overall announcements. The S&P 500 Index lost 1.34% yesterday, while the Dow sank over 1.74% on the news.

However, investors may have been more focused on another sharp rise in long term rates rather than the disappointing earnings of a few companies. For the first time since the end of 2013, the 10-year Treasury yield breached 3% in intraday trading on Tuesday. Similar to the financial market moves in late-January, investors are experiencing another bout of anxiety over potentially higher rates and their effect on the Fed’s tightening plan.

Caterpillar, a name brand for construction and industrials, declined 6.20% after management startled investors by commenting that the current quarter’s numbers are likely to be the highest for 2018. The industrials and materials sectors of the S&P 500 sank the most during the market decline, followed closely by information technology. Tech stocks seem to have come under fire again from investors as fears over increased regulation may be driving some shareholders to capture remaining profits from the best-performing sector over the last 12 months, gaining over 24% compared to the S&P’s overall return of 13.16%. We believe this minor pullback in stocks may end up being a short-lived trend, especially as earnings in S&P 500 companies reached a noteworthy 25.51% growth rate with over 150 companies reporting so far.

Bond markets were fairly flat, declining 0.08% yesterday according to the Barclays U.S. Universal Index, as rates continued their precipitous climb. The 10-year Treasury has risen from 2.74% at the start of April to 3.00% as of yesterday. The realization that rates may start to normalize – heading higher after years of suppressed levels à la the Fed – and the consequent reassessment of valuations in financial markets will likely be key concerns for investors over the near term. A quiet rise in commodity prices has added to the disturbance as investors evaluate the potential inflationary impact going forward. The growing supply of U.S. debt may also become trouble for bond investors as the Treasury increases its issuance to meet budget obligations, while the Fed simultaneously raises rates and trims its balance sheet. The Treasury Department will be issuing $96 billion in fixed-rate notes this week – the largest of its kind since 2014, according to Bloomberg.

Geopolitical risk seems to be subsiding, at least temporarily, but it may be yet another upward pressure on rates. Relations between the U.S. and China seem to be on the mend as both countries plan official talks over ongoing trade disputes, while North Korea announced it has suspended its long-range missile tests and will cease nuclear testing ahead of landmark talks with South Korea and a summit with other leaders, including the U.S. and China. This source of risk, which had surged in recent months, has now declined over recent weeks and has likely had an effect on the demand for safe-haven assets like Treasuries.

The Global Investment Management team maintains our view for modestly positive returns for stocks in 2018. The current earnings season will likely be one of the strongest in recent memory as tax cuts impact the bottom line; however, earnings outlooks for certain sectors may become an issue in the coming quarters. Our team continues to emphasize the normalization of stock market volatility and interest rates is to be expected, and will likely continue going forward. Our strategies remain slightly overweight to stocks, underweight to bonds, and neutral on alternative assets. The main events we continue to be vigilant for are inflation-influenced changes to the Fed’s rate path, the potential for disappointment in aggressive earnings forecasts, and any unexpected changes in economic data.

Chart showing various market returns as of 4/24/18

Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Diversification and asset allocation do not ensure a profit or guarantee against loss.


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