Despite a summer of geopolitical unrest, investors'
optimistic view of U.S. stocks has been largely unscathed. The Dow Jones
Industrial Average's 185.66-point rise Friday was just its fourth gain in the
past 13 trading days. The 30-stock index has tumbled since its July 16 record
high and is down 0.1% for the year.
A wave of risk aversion has punished stocks and fueled the
largest-ever retreat from junk bonds. Investors are contending with violence in
Ukraine, Iraq and the Gaza Strip, along with news that Italy faces its third
recession since 2008 and Germany's industrial production is slowing.
Some investors are concerned a sharp rise in asset prices
has outpaced uneven global economic growth. Others worry how markets will
respond when the Federal Reserve fully withdraws its monthly stimulus, which is
widely expected this fall. Yet many fund managers say that unless the unrest
increases and threatens the global growth outlook, the case for buying U.S.
stocks appears stronger than that for bonds and many other assets.
Corporate earnings topped expectations in the second
quarter, advancing at the second-fastest rate since 2011, according to FactSet.
Meanwhile, labor and manufacturing data show the U.S. economy is improving
without worrisome inflation.
In the week ended Aug. 6, investors pulled $16.41 billion
from stock mutual and exchange-traded funds, the largest weekly outflow since
February, and $7.07 billion from junk funds, the largest outflow ever.
Investors poured $7.84 billion into money-market funds that act as a cash
substitute, after three weeks of outflows, according to Lipper data.
Government bonds have benefited; the 10-year U.S. Treasury
yield fell to its lowest since June 2013 on Friday, at 2.420%, while the yield
on 10-year German bunds hit a record low of 1.02%. Yields fall as prices rise.
Robust corporate earnings are helping to boost optimism.
Companies in the S&P 500 are on track to post earnings growth of 8.4% for
the second quarter, well above midyear forecasts for a 4.9% rise, according to
FactSet. Revenue is on pace to advance 4.3%. The estimates are based on results
from 446 companies in the S&P 500 that had reported through Thursday morning,
and analysts' forecasts for the rest.
The S&P 500 trades at about 15.1 times analysts'
expectations for its components' earnings in the next 12 months. That is
modestly higher than its average of 14.1 over the last 10 years, according to
FactSet. But the valuation is lower than where it was at the start of 2006,
when the index rallied 14%, and at the beginning of a 26% rally in 2003.
Junk bonds have taken a beating recently. The Barclays U.S.
High Yield Index posted a negative total return of 1.38% from the start of July
through Thursday. Nevertheless, the junk bond market still has handed investors
a total return of 4% this year through Thursday, including price appreciation
and interest payments, beating the 3.18% return on U.S. Treasury debt,
according to data from Barclays PLC.
Some investors worry last year's 30% increase in the S&P
500 may have borrowed from future gains, setting the market up for a
down-to-sideways period. And some analysts say softness in smaller-company
stocks such as those that make up the Russell 2000 index can point to
underlying weakness in the U.S. economy, to which smaller companies tend to be
more exposed to than larger ones.
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