Market Commentary

• Stocks, oil prices, and Treasury yields have been on a roller coaster ride since the U.S. attacked Iran.
• The jump higher in inflation and a continued lack of progress in Iran negotiations will likely keep markets volatile.

Some of our regular readers may look at the title of this week’s issue and question what this author is talking about. After all, it seems the S&P 500 Index (SPX) is setting new all-time record highs regularly with few large downside days. If you are invested at the index level, you are likely not complaining when you open your monthly statement. But there is plenty of churn if you look underneath the hood.

The Information Technology sector, after performing poorly the first three months of the year when the Energy sector was the star of the show, has rallied a robust 45.2% since the beginning of April and has been the best performer while Energy is dead last over the same time frame. From last place in the first quarter to first place in the second. And, importantly, tech companies are expected to post strong earnings results in coming quarters. Now that is what you call a performance roller coaster ride.

Oil prices and Treasury yields have also been on a roller coaster ride since the U.S. attacked Iran. West Texas Intermediate (WTI), the U.S. benchmark, has experienced multiple 5% to 10% moves up or down in a single day and on a couple of days even more. Traders are tied to the headlines, trying to decipher whether a peace deal is near or not. The world has largely been operating on oil reserves since the conflict began, and global stockpiles are declining. The International Energy Agency projects the crude-oil supply restriction to become sharper and more economically damaging globally by July and August. Shortages and rationing are more a problem for the developing world, but the longer the diplomatic impasse is drawn out over the next month or two, the more persistent U.S. and global inflation should be.

How about U.S. Treasury yields? On the day prior to U.S. military action, the 10-year yield was sitting right at 4%. The initial move in price when the attack began was up (yields down), but that was short-lived as investors quickly concluded that higher oil would likely quickly lead to higher inflation. By the end of March, the yield was up near 4.5% and traded as high as 4.67% in mid-May before falling back to the current 4.45%. We believe the jump higher in inflation and a continued lack of progress in negotiations could easily push yields noticeably higher.

We do see pressure building quickly on both the U.S. and Iran to make a deal that reopens the flow of energy to the world, but, even with a deal tomorrow, inflation figures to be part of the outlook for the rest of the year. In our view, investors may consider adding money to industries that can pass on higher input costs to their business customers, including the Industrial Gases and Machinery & Equipment industry groups. And we favor Aerospace & Defense, anticipating a restock of the U.S. arsenal. Meanwhile, we believe the technology spending trend has persistence but may become expensive as it did last year. It is for this reason that we favor Utilities, Industrials, and Financials to follow the technology trend at a lower cost per dollar of future expected earnings. 

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate.. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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