Earnings Acceleration Likely Needed for Next Upturn in Stocks
U.S. equities finished mostly higher last week. For a fourth straight week, the S&P 500 and Dow Jones Industrials were up (returning 0.73% and 0.57% respectively for the week), while the NASDAQ underperformed at -0.34%.1 It was a busy start for second quarter earnings. More than 70% of the 100 S&P 500 companies that have reported earnings have beaten consensus earnings per share expectations by approximately 3% in aggregate.2
But we want to watch top-line revenues carefully. Half of the companies have beaten top-line revenue estimates, and overall revenues came in flat versus expectations.3 The Financials sector outperformed on the back of good earnings reports from credit quality improvement. Technology was the worst performer, with some PC-related companies reporting disappointing results.
Weekly Top Themes
- The Fed is repeating the same message, with slight changes to make it more digestible to investors. The Fed does not intend to raise rates for a few years and decisions to taper quantitative easing depend on stronger data. Monetary conditions in most major advanced economies are likely to remain exceptionally loose for several years, even after the U.S. ends QE3.
- U.S. retail sales missed consensus expectations in June. Nevertheless, they are beating last year’s performance on both a 6- and 12-month annualized basis, consistent with an ongoing moderate economic recovery. Leading indicators continue to point to an increase in both sales and investment. Household debt service and financial obligation ratios have fallen to generational lows.
- The recent rise in oil prices should not be a significant drag on global growth. However, if prices rise much further, this will threaten our forecasts for a gradually accelerating world GDP as we move into 2014.
- The federal deficit is running $400 billion less than last year.4 Receipts so far this fiscal year have increased 14% and spending is down 5%. This is primarily due to an improving economy and higher payroll taxes. A budget surplus in a couple of years is not out of the question.
- China’s second quarter GDP slowed to 7.5%.5 The pace of growth has slowed but was expected as China transitions from a developing to developed nation. The risk in China is not weaker demand but potential policy mistakes.
The Big Picture
The outlook for domestic economic growth will dictate Fed policy, bond yields and equity prices. Risks of economic disappointment imply that bond yields could drift lower and stock prices could face renewed turbulence. However, we believe economic growth should improve later this year through 2014, likely increasing bond yields and equity prices. Housing is no longer a drag and construction has considerable upside. Most state and local government finances are on the mend. Household deleveraging is well advanced and healing in business sector confidence promises faster capital spending growth.
It is widely thought that the Fed’s easy monetary policies have been at least as important as fundamentals in driving the equity bull market. While zero short-term interest rates and quantitative easing have certainly played a role, the bulk of the equity performance over the last four years reflects higher earnings. The S&P 500 is currently trading at around 16x trailing earnings, which is only slightly above the historical average.6 We believe valuation will not constrain prices, but a positive view on the market depends on the uptrend in earnings resuming.
Equity sector leadership is shifting, prodded by the rise in bond yields and improving economic expectations. This shift should persist in the next 6 to 12 months, assuming our forecast of modestly better growth comes to fruition. As a result, we believe investors should consider underweighting defensive sectors and bond-like investments, while overweighting mid-cyclicals such as Industrials and Technology.
Yet risks remain: a faltering U.S. economy, a hard landing in China, a renewed debt crisis in the Eurozone and a spike in oil prices. But the good news is that the first big increase in bond yields has occurred and equities stayed resilient. Perhaps the “great rotation” has begun.1 Source: Morningstar Direct and Bloomberg as of 7/19/13. 2 Source: Bloomberg as of 7/19/13. 3 Source: Bloomberg, “A Bottom-Line Solution for a Top Line Problem,” July 19, 2013. http://www.bloomberg.com/news/2013-07-19/a-bottom-line-solution-for-a-top-line-problem.html 4 Source: Congressional Budget Office. 5 Source: Bloomberg, “European Stocks Advance as China GDP MatchesForecasts,” July 15, 2013. http://www.bloomberg.com/news/2013-07-15/european-stock-index-futures-climb-on-chinese-gdp-report.html. 6 Source: FactSet.
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock
Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is acapitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. 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.
GPE-BDCOMM2-0713P
© Nuveen Asset Management
