In a continuation of a pattern that has been in place for several weeks, investors have been moving away from smaller-capitalisation stocks and growth styles and into large caps and value stocks.
Against this backdrop, it’s not surprising that the major averages reported mixed results. The large-cap-dominated Dow Jones Industrial Average gained 0.4 per cent to close at 16,583 points, the broad market S&P 500 index fell marginally to 1,878 and the tech-heavy Nasdaq composite declined 1.3 per cent to 4,071.
In fixed income markets, Treasury yields rose slightly (as prices fell), with the 10-year moving from 2.58 per cent to 2.62 per cent.
Although corporate earnings have remained solid and the economic data has been pointing to improvement, investors have been rotating out of stocks. The most recent weekly figures show that investors sold more than $9bn (£5.3bn) worth of equity funds.
As has been the case for some time, the selling is most acute among last year’s leaders – the growth and momentum areas of the market. One high-profile example is Twitter, which lost 18 per cent after its initial public offering lock-up period expired. Tesla Motors, another case in point, has lost approximately one third of its market value since late February.
While the stockmarket is enduring a spate of selling, the opposite is occurring in fixed income markets. Investors are still pouring money into bond funds, which is helping to keep yields stubbornly low.
Several factors appear to be behind this. First, although equity markets are mostly ignoring the events in Ukraine, risk aversion is helping to drive assets into Treasuries. By our analysis, geopolitical risk is shaving approximately 0.25 per cent off of yields.
Additionally, Federal Reserve actions and statements are helping to keep yields low. Earlier this month, Fed chair Janet Yellen highlighted concerns over the housing market, which investors took as an indication that the central bank was committed to remaining accommodative, given the still-present fragility in the economy.
Some areas of the market appear fully (if not over) valued. The prevailing market trends and crosscurrents come with several notable investment implications.
Low yields in fixed income markets have many investors aggressively gravitating towards any assets that offer incremental income. As a result, one area of the market that is starting to appear fully valued is high-yield bonds.
Conversely, as investors move into relatively safer areas of the stockmarket, some defensive sectors, including healthcare, consumer staples and utilities, are starting to look richly valued. This has many stocks in these sectors trading at a premium. Utilities stocks, in particular, are looking vulnerable in our view.
Last year, we grew increasingly cautious towards utilities when interest rates started to rise, since this sector often serves as a proxy for the bond market. In the current environment, with more money pouring into the sector, utilities stocks again appear expensive.
This backdrop, combined with the fact that we expect interest rates will gradually rise over the second half of 2014, presents an argument for trimming positions in that sector.
Russ Koesterich is global chief investment strategist at BlackRock
