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April Commentary

The U.S. stock market continued its strong rally last month, now up 18% since last July. One of the interesting facets of this rise has been the relative quiescence of  bond yields in that period- the 10 year Treasury yield has risen only 0.25 percentage points to 1.75%. The yield on the 30 year Treasury- far more volatile since an investor has to wait longer to get their money back- is at 3.0%, up half a percentage point since July. In contrast, back in August 2011, the stock market had a rally very similar to the current one, again up nearly 20% by the following March. That time, the yield on the 10 year and the 30 year each rose by a full percentage point. Of course a big factor, as we talked about last month, is the open ended asset purchases that the Federal Reserve has committed itself to at this time... they have to find some place to spend $85 billion every month. 

Something else to keep in mind- helping keep rates low has also been the underwhelming recent performance of commodities. Generally speaking, commodity prices should be somewhat correlated with economic growth- as economies grow, so do appetites for commodities, pushing their prices higher- and by extension, the stock market. That correlation between commodities and stock performance has been particularly strong since 2009. However, there has been a noticeable break in the relationship over the last year, as commodities have declined. The following chart measures the correlation between the returns of the S&P 500 and a broad commodity index since 2009. A correlation of 1 means the two go up and down together in tandem, while a -1 means that one goes down when the other goes up.

This is helpful in keeping rates down because rising commodity prices fuel inflation and rising inflation leads to higher interest rates. A similar breakdown has occurred between stock prices in the U.S. and emerging markets. Emerging markets are often linked to commodity prices as the export of commodities is a prime driver of their economies.

A few years ago, many economist were predicting a "decoupling" of emerging and developed markets. They were right... kinda. We are pretty sure they meant emerging markets would outgrow their peers, not the other way around.

Falling or flat commodity prices are not necessarily a bad thing. In the 1990's, the U.S. economy grew strongly as commodity prices remained relatively flat. The flat prices today could be the result of increased investment in supply, but there is also the possibility demand is not growing nearly as much as might be expected judging solely by stock prices. 

One final chart- many market participants will tell you that the single best indicator of economic growth is the price of copper. Because copper has so many industrial uses, the demand for it tends to correlate with the economy. Over the last year, in stark contrast to stocks, copper has declined over 10%.