Fed Inaction Lengthens Reflationary Economy

U.S. equities advanced last week as the S&P 500 increased 1.32%.1 The Federal Reserve (Fed) delivered a big surprise by leaving intact the current $85 billion monthly purchase program. The Committee appears nervous about the resiliency of the economy. Chairman Bernanke pointed to three factors for postponing tapering: 1) the need for more labor market data to be confident in the outlook, 2) a desire to assess the degree to which tighter financial conditions, particularly mortgage rates, are affecting the real economy and 3) an interest in gaining clarity on “upcoming fiscal debates.”

The Taper Delay Has Positive Impacts and Tradeoffs

We do not believe the FOMC intended to surprise investors. The Fed has consistently communicated that an improving economy, stronger labor market and modest infla- tion were needed before adjusting policy. The main positive from the Fed’s inaction is that interest rate expectations have been lowered, providing support for interest- sensitive parts of the economy. The decision to extend quantitative easing may lend credibility to the Fed’s pledge not to raise rates for a long time and should delay the first rate hike. This should be reflected in lower rates across the yield curve. But the positive impact on rates likely has two costs: 1) markets are likely to be more volatile and 2) the credibility of future Fed policy signals may suffer.

Weekly Top Themes

1. President Obama eliminated two major overhangs that will allow for a pivot to budget battles. Secretary of State John Kerry reached agreement with Russia on inspections for Syrian chemical weapons. The United Nations will need to take up the agreement at some point, but the strain on scarce political capital from the President has been pushed to the background. The elimination of Larry Summers from candidacy for Fed Chairman removed a major division in the Democratic Party. Attention is now on the continuing resolution and debt ceiling increase. Since the parties are sharply divided, reaching a budget agree- ment could be difficult. Any new budget deal will result in very little fiscal drag, and the risk of future downgrades has declined as the budget deficit and debt-to- GDP ratios have improved.

2. We anticipate relatively stronger industrial production data over the next three to six months. Our view is supported by strong U.S. auto sales, a modest upswing in European growth and a stabilizing in China. Although recent data has been mixed, forward-looking indicators have been strong.

3. Price/earnings expansion has led the equity market gains and is close to running its course. Future gains require improvement in earnings growth. Fortunately, jobs and housing data appear to be headed in the right direction. As the Fed contemplates an exit strategy for bond purchases, better future economic conditions would make earnings growth more achievable.

The Big Picture

In summary, we continue to recommend a moderately pro-cyclical bias for U.S. equity portfolios. The U.S. economic recovery is gradually solidifying and broadening. Outside the U.S., prospects are slowly beginning to brighten, including in China, Europe and Japan. Now that domestic and global economic growth are on the mend, U.S. earnings growth should rebound as revenue and margins gradually improve and support upside in equity prices in the year ahead. In our opinion, equity valuations remain reasonable and attractive relative to bonds.

The eventual onset of Fed tapering and the unsettled Treasury market could continue to cause near-term choppiness for equities. However, we anticipate the underlying uptrend in equity prices will remain intact. Tapering does not imply an actual tightening of monetary policy. The Fed’s balance sheet will continue to

expand at least through mid-2014, keeping liquidity conditions and monetary policy highly reflationary. It is too early to discuss rate hikes, but Fed tapering will raise periodic doubts about the durability of economic growth. As the market becomes less liquidity-driven and bond yields grind higher, earnings growth is likely to become a more important driver of sector and security performance.

Headwinds are probable in a slower growth world. For now, we will continue climbing the wall of worry one issue at a time. Improvement in leading indicators continues to accelerate and suggests faster earnings growth and progress for investor sentiment in the future.

2013 Performance Year to Date




S&P 500






FTSE 100 (UK)






FTSE MIB (Italy)



Nikkei225 (Japan)



Hang Seng (Hong Kong)



Shanghai Stock ExchangeComposite(China)



MSCI World Ex U.S.






1 Source: Morningstar Direct, as of 9/20/13.

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 a capitalization-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.


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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