OREANDA-NEWS. July 19, 2016. After Friday’s failed coup attempt, stocks in Turkey were trading lower by almost 5.0 percent on Monday. The fallout elsewhere appears to be limited otherwise. The Stoxx Europe 600 index is fractionally higher halfway through Monday’s trading session, after stocks in Asia were mostly higher overnight. The political climate in Turkey and the implications for the region remain uncertain.

The government’s reassertion of control will stabilize conditions for now. But the tension between authoritarianism and freedom, and between a religious and secular society remain. Turkey’s pivotal role as a bridge between Europe and Asia, as a member of NATO, and as a partner in Europe’s attempt to manage the flow of refugees from the Middle East make its political future of vital importance to the west.

Investors Turn their Attention to Politics

Politics in the United States is of vital importance worldwide, and the presidential race shifts into high gear this week. The Republican national convention opens in Cleveland, while the Democratic convention convenes the following week in Philadelphia. Aside from the spectacle of the process, the conventions will allow investors to get a clearer sense of the respective party platforms and their potential impact on capital markets. Contrasting positions on taxation, trade, regulation and spending between the two parties could have widely varying implications for certain sectors of the U.S. economy. Starting this week and continuing through the election in November, domestic politics will become increasingly important to the performance of markets.

According to Real Clear Politics, the latest polls from Sunday show Clinton with a mid-single digit lead in a head-to-head contest with Trump. Of course, any party’s ability to implement its own legislative agenda depends not only on control of the White House, but also of Congress. So, there is much to be decided and a long way to go before we get to November.

Economic Fundamentals and Earnings Remain Critical  

In the wake of the Brexit vote, the attempted coup in Turkey and U.S. political conventions, investors can’t be blamed for being preoccupied with politics. But economic fundamentals still matter. And last week’s reports on U.S. retail sales and industrial production were the latest signs that the domestic economy reaccelerated in the second quarter. These reports followed earlier evidence of strength in the labor market, as well as in both ISM manufacturing and services. This week’s focus will be on the housing sector, which has been a source of steady growth and has received an additional boost from the recent fall in mortgage rates.

It is still early in the second quarter earnings season, but on balance it is off to a good start as the banks have generally exceeded muted expectations. Nevertheless, earnings are once again expected to decline for the quarter, placing increased importance on the widespread expectation of a return to growth in the second half. The S&P 500 established a new high last Thursday before drifting slightly lower on Friday, pushing the trailing P/E ratio to its highest level since 2010 at 19.4X, according to Factset.  

Rising risk appetites were also seen in bond markets as the yield-to-maturity on the Bank of America Merrill Lynch High Yield Bond index fell 25 basis points last week to 7.00 percent. It began the year at 8.90 percent and rose as high as 10.17 percent in early February. The option adjusted spread to governments fell 46 basis points last week to 588, down from 695 to start the year and down from a peak of 887 in February. Contributing to that spread compression was the retracement of Treasury yields, as the ten-year note climbed 19 basis points on the week from its record low following the Brexit vote. Despite events in Turkey, the yield on the ten-year is fractionally higher in early trading this week.

The better economic data in the U.S. last week pushed expectations for the next Fed rate hike somewhat higher. After ending the previous week with just 21 percent odds of a hike by December, those odds ended last week at 44 percent. However, the prevailing view is that central banks will remain exceedingly accommodative as the full implications of global politics remain uncertain.

Important Disclosures:       
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The STOXX Europe 600 Index is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid and small capitalisation companies across 18 countries of the European region.
The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
The Borsa Istanbul 100 Index is a capitalization-weighted index composed of National Market companies except investment trusts. The constituents of the BIST National 100 Index are selected on the basis of pre-determined criteria directed for the companies to be included in the indices.
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