U.S. equities were mixed last week as the markets were broadly unchanged.1 The October FOMC statement was a bit more hawkish than expected, causing concern that the recent delay in tapering may have been too aggressive. Other worries appear to be tail risks surrounding a possible Fed liquidity trap and accompanying asset bubbles. Economic data were mixed as markets struggle with the trade-offs between recovery and policy normalization.
Slow Economic Expansion Could Slow Equity Advances
Earnings improved somewhat, but the acceleration was not sufficient to alleviate concerns about the extent to which multiple expansion has underpinned equities. We believe GDP growth and 2014 earnings — rather than fiscal monetary policy — will become the key concerns for equity prices. In the second half of 2013, growth has been undercut by the July oil spike, the Fed’s indecision on tapering and the 16-day government shutdown. As a result, we anticipate that economic data in October will be weaker than in September.
While we have some concerns about stock prices, we disagree with those who believe a stock market bubble is in progress. Bubbles tend to be long, multi-year trends tied to a secular growth pattern, leading investors to believe it will be different this time around. Also, bubbles are often accompanied by new and creative forms of leverage that can create over-invested positions. These criteria do not exist today. The most consistent trends preceding market declines are generally higher oil prices, tighter policy rates or significant global crises. An expensive market has not historically been a precondition for a major market decline.
Weekly Top Themes
1. Fed policy remains largely unchanged after the meeting last week. QE tapering is still on the horizon but not beginning yet. The Fed remains dependent on stronger data, with a focus on the U.S. labor market and financial conditions.
2. Private sector employment increased by 130,000 jobs in October and almost met the consensus view, according to the ADP employment report.2 Similar results are expected from the Bureau of Labor Statistics data on November 8.
3. Home prices appreciated 1.3% as shown in the Case-Shiller home price survey. The year-over-year increase of 12.8% for the 20-City Composite was the strongest gain since 2006.3
4. Earnings season has held few surprises since companies typically set the bar low enough to clear by a modest margin. Growth for cyclical companies has been stronger than for defensive companies.4
The Big Picture
Equities have enjoyed a reflationary push higher, following a subdued September employment report, a modest decline in U.S.Treasury yields, a declining U.S. dollar and crude oil prices below $100/barrel.5 Increased risk tolerance and continued Fed monetary easing imply that valuations are likely to remain high and may expand. Profit models are signaling that the softness evident in the third quarter reporting season should potentially mark a turning point. Importantly, foreign-sourced earnings are poised to make some positive contribution to next year’s anticipated profit rebound if Euro area economic traction persists.This would mark a shift from the past several years when foreign profits were decelerating as a consequence of global economic weakness and U.S. dollar strength.
If equities are going to sustain a move to the upside, we believe earnings must assume a leading role. More specifically, earnings and revenues need to advance, given that profit margins are pushing the bounds of sustainability. Third quarter earnings were not momentous, and we do not anticipate the fourth quarter to be much different. This places the burden on 2014, and analysts are calling for year- over-year growth of 11%. The unofficial consensus is lower. There is still considerable skepticism about whether meaningful corporate capital spending will unfold, but we think it should improve.
Global economic activity is gradually strengthening in the U.S., Eurozone, Japan and China, supporting bullish views for equities and bearish for bonds. Although equities seem somewhat overbought in the near term, we would expect any consolidation to resemble recent short and shallow changes that have lasted a few weeks to several months, with roughly 3-7% in magnitude.
NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE
1 Source: Morningstar Direct, as of 11/1/13. 2 Source: ADP, “ADP National Employment Report®,” October 30, 2013, http://www.adpemploymentreport.com/2013/October/NER/NER-October-2013. aspx. 3 Source: Case-Shiller, “Home Prices Rise Further in August 2013 According to the S&P/Case-Shiller Home Price Indices,” October 29, 2013, http://us.spindices.com/indices/real-estate/sp-case- shiller-us-national-home-price-index. 4 Source: FactSet, Earnings Insight. 5 Source: Bloomberg, West Texas Intermediate (WTI), as of 11/1/13.
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.
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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