David Joy Weekly Markets Commentary -

The summer rally in equities ignored its doubters once again last week and carved out its sixth straight weekly gain. During that time, the S&P 500 has risen 4.7%. Since the rally initially began at the start of June, the index is higher by 11%. But the leadership of the rally has taken on a decidedly more economically sensitive complexion. In the month of August, the best performing sector in the S&P 500 has been technology, followed by consumer discretionary, materials, industrials and energy, with financials not far behind. The laggards have been utilities and telecom, both former dividend darlings, which have actually lost ground recently as investors shift out of them and into more aggressive positions.

This rotation is occurring against a backdrop of recently better economic data, at least in the United States. The most recent reports on retail sales, industrial production and even the July jobs report suggest that the economy has firmed somewhat from the slowdown earlier in the summer. This encouraging development has lent a certain fundamental legitimacy to the rally in stocks that previously seemed exclusively reliant on the prospect of additional central bank action. Even in Europe, where arguably central bank influence on market sentiment is greater, the economic performances of countries in the core of the Eurozone have held up better than expected. The German DAX index has enjoyed its own six-week winning streak, having climbed 9.8%, and from the start of June it is up 16.4%.

Unfortunately, the same cannot be said of China. The Shanghai Composite index slid 2.5% last week, coming after two weeks of gains. But otherwise this market has been in steady decline since early May, having lost 11.7% of its value, and leaving the index just fractionally above its low for the year and back to a level that last prevailed in early 2009. In rounded, local currency terms, the contrast among these markets' year-to-date performance is stark. The S&P is now higher by 13%, the DAX by 19%, while Shanghai Composite is down 4%. This weakness is also reflected in the price of copper, which has traced a similar path. Disappointment that additional monetary easing has been slow in coming has contributed to the malaise.

So, while better economic news is welcome, it is not necessarily robust. Global activity remains quite uneven, and there is still an expectation of central bank activism.

The most recent leg of the rally in equities has been accompanied by an equally impressive selloff in treasury bonds. After bottoming at a yield of 1.39% on July 24, right before European Central Bank President Mario Draghi vowed to defend the Euro, the U.S. 10-year note has spiked higher to a current yield of 1.82%. This move represents a loss of   roughly 3.5%. The back-up in the 30-year bond from a yield of 2.47 to 2.93% has meant a loss of roughly 9%. But, just as defensive equity positions have relinquished their leadership to more aggressive groups, high-yield bonds have benefitted from the flight from treasuries. As the yields on treasuries have been rising for the past four weeks, the yields on high-yield bonds have been falling. The Merrill Lynch High Yield Master II index yield has fallen 25 basis points to 7.42% since treasury yields bottomed on July 24, compressing the option-adjusted spread to 591 basis points from 640.

The question is whether the risk rally has become overextended? Certainly a move this sustained can be expected to at least pause, if not correct at some point. It would be a source of comfort if the recent economic improvement became even stronger, and it would certainly be welcome if central banks, at least those overseas, followed through on their promises with action. It would also be mildly reassuring if this were all taking place at a time of full participation and strong volume, and not during the August exodus. Nevertheless, higher prices are welcome whenever they arrive. Not getting mesmerized by them is the hard part.

Important Disclosures:
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

S&P 500 Index is an unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The DAX (Deutscher Aktienindex) is an index of the 30 most actively traded German blue chip stocks on the Frankfurt Stock Exchange.
The Shanghai Composite Index is a capitalization-weighted index of all stocks on China’s Shanghai Stock Exchange.
Bank of America/Merrill Lynch  High Yield Master II is an index of high-yield corporate bonds which measures the broad high yield market.
It is not possible to invest directly in an index.

Investment involves risk including the risk of loss of principal.  Generally, among asset classes stocks are more volatile than bonds or short-term instruments.  Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns. 

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