A lull in volatility is unlikely to last, though investors should consider becoming more constructive on U.S. small caps and continue to look to Japanese and Chinese equities for opportunities.
by Russ Koesterich, Portfolio Manager, Blackrock
Last week was a quiet week for stocks. As I was writing my new weekly commentary, the S&P 500 rose or fell less than 0.1% for four consecutive days, the longest such stretch in 25 years. The tight trading range could be attributed to countervailing forces of good economic data — namely, strong U.S. retail sales data and a decent gross domestic product report in Europe — balanced against lingering concerns over the conflict in Russia and Ukraine.
Equity market volatility has drifted back toward the low teens (around 13 on the VIX Index), but we believe this relative calm to be a temporary phenomenon. Although seasonal strength may keep volatility below normal for the remainder of the year, the situation is likely to change in 2015. A shift in U.S. monetary policy next year (i.e., Fed action to raise short-term interest rates) could lead to spikes in volatility of the type we witnessed in September and October.
Against this broad backdrop, we drew a few key conclusions.
A more favorable view toward U.S. small-cap stocks. After dramatically underperforming year-to-date, we are starting to see some shift in sentiment. We had been advocating an underweight to U.S. small caps all year, but would now favor a more neutral stance.
Confirming our preference for equities in Japan and China. We continue to see good opportunities in these Asian markets, which have been outperforming of late.
Japanese stocks surged 3% last week to a six-year high (although it surrendered most of those gains on Monday), driven by good earnings, the weakening yen and hopes that an expected tax hike will be delayed. According to local reports, Prime Minister Abe is likely to call a snap election around mid-December and postpone the sales tax increase scheduled for next October.
In China, stocks continued to rally despite weaker economic growth there. The Shanghai Composite Index rose 2.8% to a three-year high after officials approved the launch of the Hong Kong-Shanghai trading link. Until now, overseas investors were largely limited to trading on the Hong Kong exchange. The new program will give overseas investors access to $2 trillion in Chinese equities, which could be supportive of stocks there.
A wary outlook for gold. While volatility in stocks and bonds is down, it is picking up for commodities. Gold was hit earlier in the week by news that Chinese demand contracted for a third consecutive quarter. The metal traded to a new low for the year, temporarily dipping below $1,150 per ounce, before rebounding on Friday. But several factors are still conspiring against gold: a strong dollar, the prospect for rising real interest rates (in other words, the interest rate after inflation), and declining inflation expectations. Indeed, the University of Michigan Consumer Sentiment Survey showed U.S. inflation expectations declining from 2.8% to 2.6% last month. As such, we would continue to be cautious on gold in this environment.
Sources: Bloomberg (except as noted)
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.
This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular. The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective.
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