The fact that interest rates have been grinding lower – contrary to all expectations – will help to support stocks, says Russ Koesterich, the investment strategist of BlackRock.
According to Koesterich, the drop in rates can be partially explained by the still-uneven nature of the U.S. recovery. “While the broad economy is improving, there are persistent pockets of weakness, such as household spending. Retail sales unexpectedly stalled in July and have notched average monthly gains of just 0.3%, below the post-crisis average. While the consumer should be benefiting from a more robust labor market, the lack of income growth remains a significant headwind”, says Koesterich.
But beyond the challenges facing the U.S. economy, rates are also being suppressed by softness in other countries. Koesterich says that ongoing economic weakness and the lingering threat of deflation have pushed down European bond yields; German Bund yields traded below 1% last week, an all-time low.
According to Koesterich, with lower European yields making the United States more attractive in comparison, Europe’s slowdown is contributing to the persistence of low rates in the U.S. In turn, low rates are helping to support stocks, as investors have little choice but to search for return, and even income, in other asset classes.
Against this backdrop, investor behavior points to a continued search for value.
“Last week, money continued to flow into emerging markets and U.S. large caps; we also saw a reversal back into high yield. At the same time, assets are leaving other market segments with more aggressive valuations. One example: U.S. small caps, assets we’ve been cautious on for some time, continue to experience outflows. Last week, $1.2 billion came out of U.S. small-cap exchange traded funds, bringing the total outflows since March to $10 billion”, says Koesterich.