Market Update: May 30, 2017

MarketUpdate_header

Last Week’s Market Activity

  • S&P 500 Index and the Nasdaq closed at new record highs last Friday; seventh consecutive gain for S&P 500 and 20th record close year to date.
  • The combination of positive sentiment and low volatility suggests stocks may continue to absorb challenging headlines.  Investors weathered potential risks from last week’s news, including: fallout from Comey firing, growing investigation into Administration/Russia ties, White House’s 2018 budget proposal, terrorist bombing in Manchester, Moody’s China debt downgrade, CBO’s score for AHCA, and minutes from last Federal Open Market Committee (FOMC) meeting suggesting higher interest rates ahead.
  • Markets also handled disappointing economic reports, specifically weakness in new home sales, durable goods orders; instead focusing on longer-term trends such as positive global data (Germany, Japan), upward revision to U.S. gross domestic product (GDP) in the 1st quarter.
  • Orders for durable goods fell in April, but good news in the details. Drop (-0.7%) in orders bested expectations (-1.0%) and March revision was strong (details below).
  • Orders ex-transportation showed a similar pattern. Nondefense capital goods shipments ex-air, a proxy for business spending, fell slightly (-0.1%) but better than forecast, following four consecutive monthly gains.
  • For the week, stocks rose +1.5% to +2.0%, powered higher by the unusual combination of utilities and technology sectors, each up >2.0%.  Investors likely hedging their bets, counting on growth prospects of technology, but not necessarily buying into Fed’s rate outlook as “bond proxy” utilities sector rose.
  • Weakness in energy (-2.0%) as markets appeared to have already priced in extension to OPEC production cuts, but investors wanted deeper cuts and pushed WTI crude oil down by >1.5% last week (after rising for three weeks) to ~$49.00/bbl.
  • Action in U.S. Treasury market also points toward less Fed activity after expected June hike, with 10-Year Treasury yield hovering in the 2.25% range, on track for fourth straight monthly gain.
  • U.S. dollar firmed slightly (+0.1%) on the heels of solid GDP revision.
  • Stocks in Europe basically flat Friday; euro & pound sterling weakened as Conservatives’ lead over Labour has narrowed considerably in recent weeks.
    Emerging markets stocks +2.0% on the week, maintaining year to date leadership globally.

Overnight & This Morning

  • Stocks in Asia little changed amid shortage of overseas leads.
  • Yen strengthened for a third day against the U.S. dollar (USD/JPY -0.3% to 110.9)
  • In Europe, shares down fractionally (Euro Stoxx 600 -0.1%); bank stocks, weakness in business & consumer confidence weighing
  • European Central Bank (ECB) Head Draghi was critical of U.S. trade proposals in speech to European Parliament yesterday.  He also reaffirmed commitment to maintaining ECB stimulus, placing pressure on the euro.
  • Euro down -0.1% to $1.11
  • Commodities – Mostly lower, led by weakness in precious metals and agriculture, with WTI oil holding below $50.00/bbl. COMEX gold (-0.2%) to $1265 and copper (-0.6%).
  • U.S. stock, Treasury yields down slightly in muted, post-holiday trading.
  • U.S. dollar weak vs. yen but stronger vs. euro and other major currencies
  • U.S. Personal Income and Spending for April met expectations after two consecutive shortfalls. Inflation metrics in this report are. Its preferred measure of price growth, the Core PCE deflator, key inflation metric for the Federal Reserve, at 1.7% from 1.6%.

MacroView_header

Key Insights

  • The trend for business spending/capital investment is improving.  After years of hoarding cash, paying yield, and buying back shares, the business cycle has returned with upward shifts in pricing and U.S. monetary policy.  Businesses can no longer simply attempt to maintain market share, but rather, they must grow market share as the recovery/expansion enters its ninth year.
  • While personal consumption is still the primary driver of U.S. economic growth, we believe the rate of growth in the coming quarters/years will be driven by capital investment, which is taking up a larger portion of GDP contribution (details below).
  • 1Q earnings per share (EPS) (+15% year over year) faced the easiest comparisons and we look for remainder of 2017 quarterly EPS gains to hover in the mid-high single digit range. These are smaller percentage gains than what we’ve become accustomed to these past couple of quarters, but still indicative of sustained, late cycle growth accompanied by still low interest rates and inflation (details below).
  • We recognize current trading range is of concern. Despite the flattening yield curve, which could partly be the result of global sovereign credit valuations, there appears to be little stress evident in the credit markets (details below).

Fixed Income Notes

  • Despite equity markets at/near record levels, bond market continues to hang in there.  Constant maturity 10-year Treasury note up four consecutive months, Barclays Aggregate (+2.0%) and Barclays High Yield (+4.0%) providing positive returns year to date.
  • After 1.35% low last June, 10-year Treasury yield surged to 2.65% in late February/early March of this year. Since then, several factors have conspired to push yields lower, despite Fed’s plans to raise interest rates (see below). First, failure of the first vote on ACA repeal placed a great deal of uncertainty on likelihood of President Trump’s pro-growth policy agenda being fully enacted. Second, weak Q1 GDP enabled flattening of the yield curve. Third, some are projecting higher short-term borrowing costs will curb lending and growth, making it tougher for Fed to sustain 2.0% inflation target. Fourth (less sinister) reason has to do with relative valuation.  With Fed moving in a different direction from ECB and BOJ, those sovereign bonds trading at very expensive valuations, increasing attractiveness of U.S. government bonds.
  • This can be a blessing and a curse: curse is that a bid for U.S. Treasuries from global investors helps mask our spending profligacy. The blessing is global investors appear confident slow growth with low inflation likely to be sustained in U.S., without signs of excessive upside, or downside risks.
  • As a result, we continue to look for the U.S. benchmark Treasury yield to trade within the 2.25% to 2.75% range in the second half of 2017.
  • Corporate credit spreads (high yield & investment grade) remain narrow, credit default swaps (CDS) also held steady. If these critical market signposts (10-year Treasury yield, credit spreads, CDS) hold steady, financial markets likely to continue narrow trading range
  • Geopolitics may periodically cause near term uncertainty, but like equity markets, next catalyst likely move the bond market will be clarity on U.S. fiscal policy

Macro Notes

  • S&P 500 currently at another record level, 2415, but technicals suggest move to 2450-2475 within reach in coming months.
  • Bullish catalyst is necessary, could come in the form of: sustainable EPS growth, > expected GDP in Q2/Q3, less aggressive Fed in 2H17, corporate tax cuts, tax reform, global GDP etc.
  • Unfortunately, move of this magnitude highly dependent on fiscal policy changes, where uncertainty narrows trading ranges until clarity emerges.
  • Fundamentally, move toward this level can be justified, but anything above it would need more clarity on 2018 EPS increases, largely due to combination of repatriation tax holiday/reduction in corporate tax rate.
  • Assuming $130.00 in S&P 500 operating EPS this year, stocks currently trading ~18.5x calendar 2017; a move >2450 would take market price-to-earnings ratio (P/E) >19x.
  • Tax reform may be too big to achieve in current political environment, but corporate tax cuts still possible; if implemented, 2018 EPS could be >$140.00, which would bring target ranges for index 2500 to 2550 in 12 to 18 months
  • U.S. Q1 Real GDP revised higher from +0.7% to +1.2%, helped by a more positive picture of business investment, which had already posted a strong quarter, and a slightly better picture of consumer spending. The improvement alleviates some concerns of Q1 weakness and increases the likelihood of a Fed rate hike in June. Looking at Q2 GDP, prospects are for much stronger growth, and could be in the +3.0%, as pent up demand in cap-ex, housing, and an inventory rebuild from Q1 weakness propels GDP higher.
  • Though components of the durable goods report (airlines, transportation) can be volatile, the trend over the past year for orders (business investment) is still up approximately +5.0% year over year, despite last month’s weakness
  • A host of European economic data was released overnight, generally showing that the economic recovery continues, but at a somewhat slower pace than expected. The highlighted number was German inflation, running at 1.4%, below forecast and previous readings of 2%, which is also the ECB target rate. This data reduces some pressure on the ECB to alter its current monetary policy.
  • Politics continue to foil plans for European certainty. Just three weeks ago, the election of a Conservative government in the U.K. was seen as both a certainty and a boost for Prime Minister Theresa May. In the past few weeks, a Conservative victory, while still likely according to the polls, is now less certain. The British pound has also weakened, not coincidentally. In addition, there have been renewed calls for an early election, as soon as September 2017, as opposed to the 2018 election now expected. An early election would likely focus directly on the EU and the euro.
  • Corporate Beige Book supports strong earnings outlook. Much like first quarter earnings results and management guidance, our measure of corporate sentiment based on our analysis of earnings conference call transcripts was better than we expected. We saw a sharp increase in strong and positive words over the prior quarter, with no change in weak and negative words. Wwe believe the positive tone from management teams supports a favorable earnings outlook in the quarters ahead.
  • New highs and no volatility, more of the same. The S&P 500 Index closed at another new high on Friday, making it seven consecutive higher closes. It hasn’t been up eight days in a row since July 2013 and the previous two seven day win streaks ended at seven days. It also gained 1.4% for the week, avoiding its first three week losing streak since before Brexit. Last, the incredible lack of volatility continued, as the S&P 500 Index traded in a range of only 0.19% on Friday, the smallest daily range since March 1996 and the smallest daily range while also closing at a new all-time high since August 1991.
  • June is a busy month for central banks. Summer is nearly here and historically that has meant lower volume, but potential market volatility. As we turn the calendar to June, the three big events this month are all from central banks: as the Fed, the ECB, and the BOJ all have meetings to decide interest rate policy. These events, along with a few others, could make for an eventful month in June.

MonitoringWeek_header

Monday

  • Memorial Day Holiday
  • Eurozone: Money Supply (Apr)
  • Japan: Jobless Rate (Apr)

Tuesday

  • PCE (Apr)
  • Conference Board Consumer Confidence (May)
  • France: GDP (Q1)
  • Germany: CPI (May)
  • Eurozone: Consumer Confidence (May)
  • Japan: Industrial Production (Apr)
  • China: Mfg. & Non-Mfg. PMI (May)

Wednesday

  • Chicago Area PMI (May)
  • Beige Book
  • France: CPI (May)
  • Germany: Unemployment Change (May)
  • Eurozone: Unemployment Rate (Apr)
  • Italy: CPI (May)
  • Eurozone: CPI (May)
  • India: GDP (Q1)
  • Canada: GDP (Mar)
  • Japan: Nikkei Japan Mfg. PMI (May)
  • China: Caixin China Mfg. PMI (May)
  • Japan: Capital Spending (Q1)

Thursday

  • ADP Employment (May)
  • Non-Farm Productivity (Q1)
  • Initial Jobless Claims (May 27)
  • Markit Mfg. PMI (May)
  • ISM (May)
  • Eurozone: Markit Eurozone Mfg. PMI (May)
  • Italy: GDP (Q1)
  • Brazil: GDP (Q1)
  • South Korea: GDP (Q1)
  • Canada: Markit Canada Mfg. PMI (May)
  • Japan: Vehicle Sales (May)

Friday

  • Change in Nonfarm, Private & Mfg. Payrolls (May)
  • Unemployment Rate (May)
  • Trade Balance (Apr)
  • Eurozone: PPI (Apr)

 

 

 

 

 

Important Disclosures: Past performance is no guarantee of future results. The economic forecasts set forth in the presentation may not develop as predicted. The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Stock investing involves risk including loss of principal. Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks. Treasury Inflation-Protected Securities (TIPS) are subject to interest rate risk and opportunity risk. If interest rates rise, the value of your bond on the secondary market will likely fall. In periods of no or low inflation, other investments, including other Treasury bonds, may perform better. Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk. Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards. High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors. Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply. Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained. Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. This research material has been prepared by LPL Financial LLC.

Market Update: March 6, 2017

MarketUpdate_header

  • Equities move lower to begin week. U.S. stocks are moving lower in early trading, following their European counterparts on little news. The major averages all managed to squeak out slight gains on Friday; the S&P 500’s 0.1% gain was led by financials and healthcare, which both closed up 0.4%. Overnight in Asia, stocks finished mostly higher with the exception of Japan’s Nikkei (-0.5%) as the yen strengthened; the STOXX Europe 600 is lower by 0.5% in afternoon trading. Meanwhile, the yield on the 10-year Treasury is near flat at 2.48% as market-implied expectations of a Fed rate hike in March are near 86%, WTI crude oil ($53.25/barrel) is slightly lower, and COMEX gold ($1231/oz.) is climbing 0.4%.

MacroView_header

  • Brexit, EU summit, China forecasts, Fed “quiet period”, and February jobs report highlight week ahead. Other than the February employment report (due out this Friday, March 10)  it’s a relatively quiet week for U.S. economic data. It’s also the unofficial quiet period for the Federal Reserve ahead of the March 14-15 FOMC meeting. The overseas calendar is chock full of potentially market-moving events, including the EU leaders summit, a potential House of Lords vote on Brexit, the European Central Bank meeting, and a few key reports on China’s economy in February.
  • Beige Book. This week, we’ll examine the Fed’s latest Beige Book, looking for signs of any impact from the new Trump administration, an overheating labor market, rising wages, and inflation ahead of next week’s FOMC meeting.
  • Corporate sentiment improved again in our latest Corporate Beige Book. Sentiment improved among corporate executives based on our analysis of fourth quarter earnings conference call transcripts. Not surprisingly, policy was a popular topic, as corporate tax reform, infrastructure and regulation saw big jumps in the number of mentions. Currency and China also continued to garner a lot of attention, while energy and Brexit faded. The solid fourth quarter results coupled with improved sentiment from corporate executives support our expectation of mid-to-high single digit earnings growth for the S&P 500 in 2017.
  • The Chinese National People’s Congress began its annual meeting on Sunday. Nothing shocking has come out of the meeting so far, though little was expected. Official economic growth forecasts have been cut to 6.5%. The focus of the meeting has been on economic stability, including a reduction in monetary growth targets and efforts to reduce China’s bad debt problem. The most notable change in language related to calls for further currency liberalization. A more market-oriented currency policy suggests potential weakening of the yuan, which would run counter to China’s long-term political goals, as well as increase the likelihood of China being labeled a “currency manipulator” by the Trump administration.
  • Make that six in a row. The S&P 500 was up 0.7% for the second consecutive week, and managed to close at a new weekly all-time high. In the process, it closed higher for the sixth consecutive week for the first time since a six-week win streak off of the February 2016 lows. The last time it was up seven weeks in a row was late 2014. Here’s the catch, the S&P 500 was up only 4.9% the past six weeks – making this one of the weakest six-week win streaks ever. Given the historically small daily trading ranges recently, this shouldn’t come as a big surprise. You have to go back to late 2013 for the last time there was a smaller return during a six-week win streak.

MonitoringWeek_header

Monday

  • Kashkari (Dove)

 Tuesday

  • China: Imports and Exports (Feb)
  • Japan: Economy Watchers Survey

 Wednesday

  • ADP Employment (Feb)
  • China: CPI (Feb)

Thursday

  • Initial Claims (3/5)
  • Challenger Job Cut Announcements (Feb)
  • Household Net Worth and Flow of Funds (Q4)
  • European Union leaders Summit in Brussels Begins
  • Eurozone: European Central Bank Meeting (No Change Expected)

Friday

  • Employment Report (Feb)
  • European Union leaders Summit in Brussels Continues

 

 

 

 

 

Important Disclosures: Past performance is no guarantee of future results. The economic forecasts set forth in the presentation may not develop as predicted. The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Stock investing involves risk including loss of principal. Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks. Treasury Inflation-Protected Securities (TIPS) are subject to interest rate risk and opportunity risk. If interest rates rise, the value of your bond on the secondary market will likely fall. In periods of no or low inflation, other investments, including other Treasury bonds, may perform better. Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk. Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards. High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors. Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply. Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained. Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. This research material has been prepared by LPL Financial LLC.

Investment Directions: So What Should I Do With My Money?

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Provided by 401kcalculator

United States

We are underweight U.S. stocks. After its June policy meeting, the Fed signaled that it was getting close to raising short-term interest rates on improving economic conditions and promised to move gradually. Yet turmoil surrounding Greece and China has brought more uncertainty to the global economic outlook, which could give the Fed some pause. To begin with, there is reason to proceed with caution. The latest U.S. readings on jobs and the housing market point to an economic reacceleration in the second half, but soft spots remain. Measures such as retail sales and durable goods continue to show weakness. And, the Chicago Fed National Activity Index (CFNAI), a good leading indicator for the country’s overall economic health, has inched higher but is still running below trend (see the chart below).

Given that valuations of U.S. stocks are relatively pricey, we tend to search abroad for better value and opportunities. But we think U.S. stocks have further upside potential, keeping in mind that mergers and acquisitions just hit a new high in the second quarter. It is still early in the second-quarter earnings season, but with estimates having already been lowered, the U.S. economy recovering and the dollar having stabilized, companies should have an easier time beating estimates this time around.

Turning Insight Into Action

Many measures of U.S. economic activity have improved since the slowdown early in the year. While weakness lingers in some areas, the U.S. economy looks set to regain speed. Selectivity is important in the U.S. market, where value will vary by sector and individual company.

Consider blending opportunities for core market exposure with high- conviction active solutions that focus on finding value in the market.

CONSIDER

iShares Core S&P 500 ETF (IVV), iShares Core S&P Total U.S. Stock Market ETF (ITOT), Basic Value Fund (MABAX)

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International Developed Markets

We hold an overweight to eurozone equities. Uncertainty surrounding Greece and its membership in the euro area will keep risk premiums and volatility elevated; however, we think fallout from the Greek drama will remain contained and short- lived (see Hot Topic on page 7). In fact, with economic data coming roughly in line with forecasts and profit expectations firming, any further volatility in eurozone equities could present an opportunity. This is especially true since the European Central Bank (ECB) is expanding its balance sheet and is poised to provide further monetary accommodation if needed. Any continued euro weakness associated with these events will likely give an additional kick to earnings as profits are repatriated. That said, investors should consider hedging their currency exposure to eurozone equities to avoid returns being eroded by euro weakness.

We are overweight Japanese stocks. Somewhat sheltered from this year’s financial market roller coaster ride, Japanese equities have not only been an island of relative calm and tranquility (see the chart below) but also an area of strong outperformance. Japan’s economy, while certainly not a locomotive, has managed to pull out of a shallow and brief recession and is beginning to show signs of benefiting from a weaker yen. Moreover, Japanese companies have come a long way in improving profitability, and they are also lifting dividends and share buybacks to boost return on equity. Despite outpacing the rest of the developed world so far this year, Japan remains inexpensive based on price-to-book and forward price-to-earnings ratios.

We have a neutral view on developed Asia ex-Japan equities. A setback in Chinese stocks, slower commodities demand growth and negative earnings revisions have weighed on the region’s equity markets this year. However, after the summer selloffs, we think Asia ex-Japan equities warrant a closer look. Take Hong Kong, the Hang Seng Index has very recently regained some lost ground, but not before it fell to the cheapest levels versus the MSCI World Index since September 2003. Also of note are the above-average dividend yields, with Australia yielding north of 4.5%.

Turning Insight Into Action

Earnings growth and valuations of European and Japanese companies are more compelling than for U.S. companies. But renewed strength in the greenback could erode returns in international markets for U.S. dollar- based investors, boosting the allure of currency hedged exposure.

Consider using an active manager with strong stock selection expertise or be selective with index-based exposures.

CONSIDER

Global Long/Short Equity Fund (BDMIX), Global Dividend Fund (BIBDX), Global Allocation Fund (MALOX), iShares MSCI Japan ETF (EWJ), iShares Currency Hedged MSCI Japan ETF (HEWJ), iShares MSCI Eurozone ETF (EZU), iShares Currency Hedged MSCI Eurozone ETF (HEZU), iShares International Select Dividend ETF (IDV)

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Emerging Markets

We hold a benchmark weight to emerging markets. Since topping out at the end of April, emerging markets have entered another correction phase, and the selloff has been quite indiscriminate. While markets have stabilized somewhat very recently, emerging Asia has clearly dominated price action since the end of June. In addition to China’s equity market woes, Latin America has underperformed again so far this year and Eastern Europe sharply declined since mid-May. However, we still prefer emerging Asia. Countries in emerging Asia have greater scope for monetary accommodation and market reforms, will likely experience better growth (though not great), should benefit most from lower oil prices and have increasingly competitive currencies.

We have a neutral weight in China with a preference for H-shares. Chinese stocks tumbled the most in nearly six years in early July after a series of measures (and some quick backtracking) paradoxically aimed at stabilizing financial market conditions backfired. While the slide has paused for now, we expect more volatility, particularly in the onshore exchanges. After downgrading China to neutral in June, we will hold off from chasing newly attractive valuations until the situation stabilizes. That said, it may be possible to find bargains in the Hong Kong-listed H-shares market, which is both cheaper and less volatile than the A-shares market. Select banks, property developers and new energy companies could present value.

It is worth noting, however, this stock turmoil has not affected the Chinese economy. The PBOC has plenty of spare power to support economic growth and financial markets, unlike some developed market central banks, and will likely continue to implement countermeasures. And when it comes down to it, we have not seen a material impact from the equity selloff on the global economy and markets to date.

We elect to downgrade Poland from an overweight to neutral. Poland’s economy is in relatively good shape and profitability is quite strong among Polish companies. However, the financials sector, which represents more than 40% of Poland’s market capitalization, faces the risk of a banking tax and other regulation if a more populist party (the Law and Justice party) comes to power this autumn, as is currently projected. Moreover, Poland no longer stands out as particularly cheap relative to other Eastern European countries, such as Turkey and Russia.

Turning Insight Into Action

It may be time to consider getting back to a benchmark exposure in emerging markets, but investors should remain selective.

Consider accessing specific countries or regions, or use an active manager with expertise to identify potential opportunities.

CONSIDER

iShares MSCI Emerging Markets Asia ETF (EEMA), iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV), Emerging Market Allocation Fund (BEEIX)

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Global Sectors

We are overweight information technology and financials. As the economy firms, loan demand should rise, which could support financials stocks. Mergers and acquisitions as well as securities underwriting business will likely remain solid, which can also prove helpful. And, technology stocks should benefit from more and more companies deciding to replace antiquated technology infrastructure.

We hold a neutral weight to the health care sector. While health care has outperformed by a wide margin this year and is a consensus overweight among money managers, valuations appear reasonable against solid earnings growth and profitability, even for biotechnology stocks. In an environment of decent economic growth, favorable credit conditions and continued good earnings growth, we would anticipate biotech especially, but also life sciences, to outperform. Meanwhile, there are good reasons to consider pharmaceuticals stocks, which tend to have very high dividend payout ratios. This could prove particularly advantageous in a risk-off scenario (defined by a renewed drop in bond yields).

We are underweight U.S. utilities and consumer staples. These sectors outperformed during the past month as heightened global risk aversion prompted a decline in interest rates and a preference for defensive sectors. But while defensives may be somewhat less expensive after this year’s repricing, any stabilization from here could entail further downside.

We have a neutral exposure to the energy sector as oil prices have declined anew in recent weeks. We prefer integrated oil and gas companies given their more muted sensitivity to oil prices in the past. What is more, their refinery businesses benefit from lower oil prices.

We are neutral in industrials. The correction in transportation stocks has investors worried that the decline may be a harbinger of bad news for the broader market. We think the decline in transports has more to do with the subsector’s overvaluation after two years of strong outperformance. Plus, declining global trade volumes, weaker-than-forecast economic activity and reduced demand for coal shipments all play a role in the subsector’s recent outsized move lower.

Turning Insight Into Action

Consider cyclical sectors over defensive and dividend-oriented sectors. Consumer staples and U.S. utilities look particularly unattractive and are vulnerable to rising rates.

Look into possible opportunities in the technology and financials sectors and consider a long/short approach to potentially benefit from any continued market volatility.

CONSIDER

iShares Global Financials ETF (IXG), iShares Global Tech ETF (IXN), iShares U.S. Technology ETF (IYW), Global Long/Short Equity Fund (BDMIX)

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Fixed Income

We are underweight Treasuries. Yields of long-term debt in the United States, Germany, United Kingdom and Japan hit their highest levels this year in June, but the upward movement was interrupted, at least temporarily, by jitters about Greece and China near month-end. Rate volatility is likely to remain elevated as markets wrestle with the timing of the Fed’s liftoff. We believe yields could climb higher over the course of the year, although much of the adjustment may have already taken place.

We hold a neutral position in Treasury Inflation-Protected Securities (TIPS). The backup in yields has returned some value to the asset class. We don’t think inflation will accelerate meaningfully anytime soon, but headline inflation and expectations have inched higher while the risk of disinflation has decreased.

We are overweight high yield. Outflows from the asset class continue and spreads are under pressure. Although volatility could persist, yields are attractive in both absolute and relative terms, and fundamentals remain encouraging.

We have an overweight in municipals. The municipal market had another negative month in June, though it performed better than the more volatile Treasuries. Puerto Rico’s debt woes grabbed headlines but had little price impact thus far on the overall muni market (see the chart below). Fundamentals of the majority of the muni market remain intact, as we anticipate minimal contagion risk. That said, if restructuring negotiations between the commonwealth and its bondholders turn contentious and drag on, this could stoke volatility for the broader market.

We are underweight in non-U.S. developed markets and neutral in emerging- market debt. Increased volatility in interest rates and risk assets, as well as the possibility of the dollar resuming its climb, could prove difficult for hard currency- denominated emerging-market debt.

We hold a benchmark weight in mortgage-backed securities (MBS). While MBS held up relatively well in the interest rate backup, mortgage spreads relative to Treasuries remain low and valuations do not suggest an attractive entry level yet.

Turning Insight Into Action

With interest rates likely to rise in the United States in 2015, fixed income investors will likely face challenges yet again this year.

Manage Interest Rate Duration

Consider a flexible strategy with the ability to actively manage duration.

CONSIDER

Strategic Income Opportunities Fund (BSIIX), Strategic Municipal Opportunities Fund (MAMTX), Global Long/Short Credit Fund (BGCIX)

Manage Interest Rate Risk

Seek to reduce interest rate risk through time by using a diversified bond ladder and matching term maturity to specific investing needs.

CONSIDER

iBonds® ETFs

Seek Income

Cast a wider net for income while carefully balancing the trade-offs between yield and risk.

CONSIDER

Multi-Asset Income Fund (BIICX), High Yield Bond Fund (BHYIX), iShares iBoxx $ High Yield Corporate Bond ETF (HYG), iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)

Build a Diversified Core

Consider using core bonds for potential diversification benefits and protection from unforeseen shocks to equity markets.

CONSIDER

Total Return Fund (MAHQX), iShares Core U.S. Aggregate Bond ETF (AGG), iShares Core Total USD Bond Market ETF (IUSB)

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For the full report, please click on the source link below.

Written by Russ Koesterich of BlackRock

(Source: BlackRock)