July was kind to bonds, REITs and commodities, but it was a rough month for stocks, particularly in mature countries. That’s only fitting, considering that the mature markets have been suffering from a toxic blend of cyclical and self-inflicted troubles. The ongoing bailout challenges in Europe a la Greece, et al. roll on, although it’s apparently in remission for the moment. In the U.S., debate about debt ceilings and default roiled the equity market, although here too there seems to be some light at the end of the political tunnel if only temporarily, thanks to last night’s compromise.
In any case, the U.S. stock market (Russell 3000) gave up 2.3% last month—the third straight month of loss and the deepest monthly reversal since August 2010. It wasn’t much better in foreign markets in the developed world: MSCI EAFE dropped 1.6% in July, which also makes three down months in a row. Emerging markets (MSCI EM) fared better by losing less, but sellers have had the upper hand here as well since May.
It’s another story in the land of bonds. U.S. inflation-indexed Treasuries in particular were the darlings of last month. The Barclays Treasury TIPS Index soared 3.9% in July, one of the strongest months on record for broad measures of these bonds. Granted, the historical record for TIPS dates only to 1997, but there’s no denying the extraordinary rise in prices for U.S. inflation-index government bonds last month.
Extraordinary because reported inflation remains relatively low by historical standards. That suggests the crowd expects higher inflation down the road. Or maybe it’s just the weird fiscal debate in Washington these days that inspires rushing into government bonds, although one could argue that the fear of a default would bring the opposite effect.
Regardless, the real yield on the 10-year TIPS has collapsed to a mere 38 basis points. For the 5-year series, the current real yield is negative (as it has been for some time), closing out the month at 72 basis points in the red. Short of a dramatic surge in inflation above the 2% to 3% range in the near term, the expected return for TIPS looks minimal at best.
If it’s yield you’re after, REITs are starting to look attractive again, at least relative to the benchmark 10-year Treasury’s nominal yield, which closed last month at 2.82%, the lowest since last November. The FTSE NAREIT All Equity Index’s trailing yield of roughly 3.4% is alluring by comparison. An extra 60 basis points may not sound like much in the grand scheme of the investment universe, but in a summer riddled with anxiety, the modest premium in REITs is attracting attention. Perhaps that explains why the MSCI REIT Index still leads the year-to-date ledger among the major asset classes with a tidy rise of 12.1%.