Ameriprise Financial - First, a look at last week.
Stocks faltered after a strong second quarter GDP report triggered concerns that the Fed might be forced to tighten sooner than expected. After the slightly softer, but still good, jobs report on Friday, a measure of stability returned to equities. But the damage had been done, and for the week the S&P 500 shed 2.7 percent, leaving the index 3.2 percent below its July 24 closing high of 1988.
Beyond the second-quarter rebound, last week's economic data was generally, but not uniformly, encouraging. Manufacturing activity and consumer confidence rose to start the third quarter, and motor vehicle sales were robust. And the economy generated more than 200,000 jobs for the sixth straight month in July, resulting in the first increase in the labor force participation rate in four months.
But housing remained sluggish, as pending home sales declined and the pace of home price appreciation slowed. In addition, the Employment Cost Index climbed more sharply than expected in the second quarter, raising concerns over potential profit margin pressure and rising overall inflation. The year-over-year core Personal Consumption Expenditure deflator rose a benign 1.5 percent in June, but climbed at a 2.0 percent pace in the second quarter, right at the Fed's long-term target.
Capital Markets React to Geopolitical Risk
The issue of geopolitical risk has generated a number of questions concerning the reaction of capital markets and the extent to which they have discounted that risk. A brief examination reveals a mixed result. Looking back to the start of the crisis in Ukraine, which began at the end of February, we see little reaction in the price of gold or oil.
On Feb. 28, when Russia invaded Crimea, gold traded at $1,294 an ounce. On July 17, when Malaysia Airlines Flight 17 was shot down, it traded at $1,319. Last Friday it closed at $1,326.
As for North Sea Brent crude oil, it traded at $106.93 a barrel. On July 17, it traded at $107.89, and closed last week at $104.84.
Stocks in the U.S. have also generally overlooked the crisis in Ukraine. Between Feb. 28 and July 17, the S&P 500 climbed 5.3 percent. And, between July 17 and just prior to last week's GDP report, it climbed another 0.6 percent.
The path of the U.S. ten-year Treasury note tells a seemingly different story. Its yield stood at 2.65 percent on Feb. 28, had fallen to 2.45 percent on July 17, and closed last week at 2.48 percent. However, its yield mostly remained above 2.60 percent until late June. Most of its decline in yield has occurred since a spike higher following the July 3 release of the blowout June employment report. And the day before the downing of Malaysia Airlines Flight 17, it stood at 2.53 percent.
High yield bond prices have been under pressure since July 7, but the weakness appears to have more to do with concerns about liquidity and rising rates than with geopolitical events. So, if there has been a market reaction to the Ukrainian crisis, it has been fairly muted, as has been the case with gold, oil and U.S. equities.
European Markets Waver
The story is a little different if we look at Europe, using Germany as our proxy. Since Feb. 28, the DAX Index is down 5.0 percent. But that is misleading. In the two weeks following the Russian invasion of Crimea, the DAX fell 7.0 percent, but it then began a rebound that took it higher by 11 percent by July 3. It has since fallen 8 percent, but half of that loss came on Thursday and Friday of last week. It was flat in the week immediately following the Malaysia Airlines crash.
So, even in Germany, which is closer to the crisis, both in geographic and economic terms, the stock market reaction seems generally sanguine.
The jury may still be out, however. Last week's selloff was variously attributed to the latest round of economic sanctions imposed on Russia by the European Union, the warning from Adidas that its revenue from Russia would be significantly harmed by the crisis, the unrelated turmoil at Banco Esprito Santo in Portugal, as well as a soft headline Consumer Price Index reading for July.
While attempting to isolate a particular cause for last week's downturn may be futile, it seems fair to say that the crisis in Ukraine has not until now been a preoccupation of German equity investors. The German ten-year note yield has recently fallen to an all-time low of 1.13 percent. Back on Feb. 28 it was 1.62 percent. But the pattern of steadily falling yield goes back to the start of the year, and seems mostly unrelated to events in Ukraine. German business sentiment has taken a hit. The IFO index has declined in each of the past three months. In contrast, consumer confidence has climbed for the past three months.
Stocks in Russia have followed a pattern similar to Germany's. They, too, are down 5.0 percent since the invasion of Crimea. But, like Germany, Russian stocks fell in the two weeks immediately following the invasion, before rallying through early July. Since July 3, the Micex index is down 9 percent. But unlike the case with German equities, most of that decline has come in the wake of the Malaysia Airlines crash. Russia is more economically dependent upon Europe than vice versa.
Argentina Defaults on Its Debt
In a different kind of crisis, last week Argentina was declared to be in default on its sovereign debt, as a U.S. judge prevented the country from making a scheduled interest payment because it had not yet reached a settlement with holdout bondholders from its last default in 2001. As the July 30 deadline approached, and default became increasingly likely, bond yields in the region began to rise. Since July 24 the yield on Argentina's debt rose 72 basis points to 10.39 percent. Last Wednesday, just prior to the declaration of default, the yield had fallen as low as 8.90 percent in hopes that a settlement would be reached.
Elsewhere in the region, Brazilian yields climbed 33 basis points on its ten-year bonds in just the past seven trading days. In Chile, however, they rose just seven basis points. Mexican yields rose 20 basis points. Equity markets in the region were also lower. In Argentina, stocks fell 8.3 percent on the day following default, but still managed to rise for the week. Stocks in Brazil fell 3.3 percent last week, while Mexico declined 0.9 percent, and just 0.4 percent in Chile. Currencies throughout the region have weakened versus the dollar as well.
The closer one sits to these situations, both literally and figuratively, it seems the greater their impact in terms of market reaction. But, at least so far, those reactions have been modest. The default in Argentina seems specific to itself, suggesting any spillover in the region will be minimal. The crisis in Ukraine could fester, however, and have somewhat wider implications, especially if energy markets become politicized should the standoff linger into the winter. At the very least, it seems clear that a deterioration in the global geopolitical condition is not reflected in current prices. Until such crises hit home, for example in the form of sharply higher energy prices, that is likely to remain the case.
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.
The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks.
The Employment Cost Index is a quarterly report from the U.S. Department of Labor that measures the growth of employee compensation (wages and benefits).
The personal consumption expenditure deflator measures the average change over time in the price paid for all consumer purchases.
The DAX (Deutscher Aktienindex) is an index of the 30 most actively traded German blue chip stocks on the Frankfurt Stock Exchange.
The Ifo Business Climate Index is a closely followed leading indicator for economic activity in Germany prepared by the Ifo Institute for Economic Research in Munich.
MICEX Index is cap-weighted composite index calculated based on prices of the 50 most liquid Russian stocks of the largest and dynamically developing Russian issuers presented on the Moscow Exchange.
Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.
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