That didn't take long. Stocks have got their mojo back, with the mid-May wobble sparked by U.S. political turmoil seemingly fading from investors' attention. Perhaps more puzzlingly, bond investors are enjoying gains too.
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Indeed, there appears to be a fragile truce between asset classes. Bonds have kept their poise even as stocks have gained, with the S&P 500 Thursday hitting a record high. U.S. Treasurys have returned 1.7% so far in 2017, according to Bank of America Merrill Lynch indexes, with bonds maturing in 15 years or more up 3.9%. Even as the U.S. Federal Reserve moves ahead on tightening monetary policy, financial conditions have actually been easing.
Many of the risks that investors were worried about at the start of the year have failed to turn into real problems, helping equities to perform well. In particular, politics hasn't been the disruptive force it might have been. While hopes of a rapid boost to U.S. growth from President Donald Trump's administration have faded, equally there has been little action on topics that might concern markets, such as greater barriers to trade. Europe's elections have offered no shocks, and the French vote was followed by a surge in risk appetite, boosting stocks and corporate bonds in Europe. Bonds meanwhile have taken comfort from signals from central bankers that point to extremely gradual shifts in monetary policy.
But how long can this persist? The key perhaps lies more in the bond market than in the stock market, where earnings have been strong, providing fundamental support. Bonds hardly look attractive, with long-dated yields still at remarkably low levels versus prospects for nominal growth. Yet bond investors appear willing to accept these returns for now: 10-year government bond yields in the U.S., U.K. and Germany have been trading in a very narrow range for much of the past six months. Any selloff has proved short-lived as investors continue to search for yield.
The path of inflation is likely to be crucial. The pickup in inflation in advanced economies this year has been amplified by the recovery in the price of oil. That effect will now diminish, and central bankers are still concerned that inflation hasn't become self-sustaining. As a result, both bonds and stocks can make a case for gains: growth is decent, but inflation is quiescent. But if inflation does hold up and central banks strike a less accommodative tone, then it is bonds that will suffer more than stocks.
So far this year has been good for both bond and stock investors. To rely on that benign picture lasting looks risky.
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(END) Dow Jones Newswires
May 26, 2017 09:56 ET (13:56 GMT)