From BlackRock: Animal spirits rule the markets these days. But does a period of penance await? Heidi Richardson discusses.

Laissez les bon temps rouler

The season of Carnival celebrations is upon us, a burst of exuberant revelry, parties and parades, which is then followed by a long period of atonement and penance. As we discuss in the new Investment Directions, our monthly market outlook commentary, investors seem to have taken the dual nature of the season to heart, demonstrating a strong desire to let animal spirits reign—despite a somber realization of the risks ahead.

Second line

Despite an occasional breather, U.S. stocks have continued their upward climb, even after the Dow Jones Industrial Average crossed the 20,000 milestone. The promise of tax reform and other Trump administration policies have continued to fuel strong risk-on sentiment, even though investors acknowledge the impact and timing of those measures is unclear. Meanwhile, the odds of a trade war with one or more trading partners have risen, poorly executed executive orders have been issued, and even a strong, market-friendly tax reform bill will take months to enact, with a long transition likely.

Bead tossing

Nevertheless, we still see the driving force for the markets as reflation: moderately rising economic growth coupled with accelerating inflation driven by expectations of fiscal stimulus. Include strong investor sentiment and it brings to mind “Hey Pocky A-Way,” the classic Mardi Gras song celebrating “feel good music.”

Iko Iko

The reflationary environment suggests both potential winners and losers. Among the potential winners: value equities, which can be helped by gradual increases in interest rates and a steeper yield curve, and small caps, buttressed by higher growth and reduced regulation. The potential losers include Treasuries and bond proxy equities like utilities.

King cake

Still, given the high valuations of U.S. stocks, investors will need to dig deeper to find opportunities in this market. Although there are pockets of value in the United States, investors may want to look overseas in Europe, Japan and select emerging markets in Asia.

Read more in the full Investment Directions report.

The iShares Barclays 20+ Yr Treas.Bond ETF (NASDAQ:TLT) was trading at $119.87 per share on Wednesday afternoon, down $0.24 (-0.20%). Year-to-date, TLT has gained 0.62%, versus a 5.77% rise in the benchmark S&P 500 index during the same period.

TLT currently has an ETF Daily News SMART Grade of C (Neutral), and is ranked #20 of 27 ETFs in the Government Bonds ETFs category.

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This article is brought to you courtesy of BlackRock.

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