What’s the most likely direction of the markets in the next thirty days? As my family and I prepare for our departure on June 6th for an extended family trip, I find myself wondering where the equity and fixed income markets will be trading when we return later in the month.
There are a number of topics on people’s minds right now. First, there is some concern that U.S. government debt will continue to drop in value. I am certainly concerned about this, but my opinion is that Treasury bonds are significantly oversold. The recent seven-year note auction went well, and 10-year rates at 3.73% are still low by historical standards. My view is that bonds will rise in the short term, and will most likely be accompanied by a modest drop in stock prices. Converse to fixed income, equities have gained significant ground and are probably a bit ahead of themselves. In the medium term, we will likely reduce longer-term Treasury positions, but not for another month or so.
More specifically on the equity side, corporate balance sheets remain healthy, the economy is rebounding, and inventories are low, all of which are good signs for earnings. Unfortunately, the health of the consumer is appreciably less bullish. Household debt levels are still high, and expectations for increases in consumer spending are at best modest. I think equity prices will continue to rise but the summer doldrums are upon us, leading me to expect a lower stock market in late June.
One of the better performing sectors in 2009 are senior loan funds. In the past six months, the closed end funds that hold these securities have enjoyed 35% gains. Loans have become a sort of proxy for high-yield debt in the recovery, although unlike junk bonds, the interest rates on loans adjust higher with the general interest rate environment.
To illustrate my point, it’s clear that in the recent higher rate environment, loan funds have not been adversely affected, which indicates that if rates ratchet up these returns may continue.