Equity averages sagged slightly last week. Strength later in the week made up for earlier weakness as the equity rally paused for the Cyprus crisis. We (and the consensus) perceive Cyprus as mainly a local problem and believe it supports our view to remain cautious with Eurozone weightings.
Bull Market will Continue, But Correction is Overdue
Last week’s flash PMI reports reminded us of the Eurozone’s economic challenges, which could worsen due to the uncertain Italian elections and the Cyprus crisis.
Global equity markets stumbled briefly on this questionable policy, making one wonder what it means to penalize savers by confiscating assets. The most recent misstep won’t likely derail the bull market, but a short-term correction is overdue given the powerful gains since last June. However, the global economy is slowly strengthening, and policy makers remain extremely accommodative. This has kept a bid under equity prices. We’ve seen many favorable signs in the economy recently — in business and consumer spending, the housing market and labor
markets. However, economic growth faces headwinds from tax increases and federal spending cuts. And portions of the global economy remain mired in recession or stagnation, reducing our export possibilities. Growth is likely to remain merely acceptable, and the unemployment rate should only slowly edge downward. This is not all bad for equities — it will keep inflation low and central bankers on our side.
Weekly Top Themes
- Cyprus’ rejection of the bailout proposal returned EMU event risk to the market, pushing risk assets down and bond assets up. Since then, we and most investors have concluded that the numbers are small relative to the risks to both sides to allow for a compromise.
- The FOMC statement came close to expectations. It reflected the somewhat better economic data, but the overall tone remained cautious and concerned about downside risk.
- It is too early to handicap a debt ceiling deal this summer. Differences between the House and Senate bills are obviously impossible to bridge. But we believe more savings are coming and we reiterate that the market seems to want a combination of tight fiscal policy and loose monetary policy.
Positioning Remains a Mild Pro-Cyclical Tilt
The economic growth outlook will continue to be the key driver of equity market performance in the year ahead. We expect global growth to slowly solidify as the year progresses and well-known threats begin to recede. This warrants a mild pro-cyclical tilt in positioning. That said, we expect a gradual global transition from the slowdown last year to belief in a sustainable (albeit only moderate) economic expansion. Equity markets will also be periodically buffeted by lingering vulnerabilities, with the Cyprus crisis the most recent example.
The U.S. accounts for one-third of global market capitalization,1 thus regional equity strategy largely boils down to a call on the U.S. The U.S. has been defensive many times in the past. Compared with its major counterparts, it has a more stable earnings profile, greater diversification and liquidity, perceived superior corporate governance and a strong equity culture. Yet some believe the U.S. can enjoy a prolonged period of outperformance as the economic recovery gains traction and drivers pay off, including shale oil/gas, a revival of manufacturing, ongoing technology leadership and perceived superior economic innovation.
Over time, with bumps along the way, we believe that modest P/E expansion is possible based on resilient earnings per share growth of mid-single digits in 2013. This is despite fiscal drags, double digit percentage dividend growth, and buybacks and acquisitions with surplus free cash flow.
1 Source: The World Bank, 12/11.
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float- adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.
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