The Muddle-Through Economy and Grind-Higher Equity Market Continue

U.S. equities finished higher last week as the S&P 500 and Dow Jones Industrial Average closed at record highs, marking the sixth straight week of advances.1 Several macroeconomic themes are important as third quarter earnings season comes to an end. Fed Chairman nominee Janet Yellen spoke before the Senate in support of current monetary policy and suggested a similar path under her leadership. Economic data was mixed for the week, and any economic weakness continues to be perceived as supporting a delay in tapering. In turn, this can be seen as positive for equities.

Fed Remains on a Similar Course

Janet Yellen did not break any new ground in her confirmation hearing, and the main policy signal is that the Federal Reserve (Fed) is likely to remain accommodative for a long time. Overall, the message implies continuity with Ben Bernanke’s tenure.

Weekly Top Themes

1. Retail gasoline prices have declined nearly $0.40 per gallon since August.2

Gas prices can be key drivers of consumer sentiment and economic growth.

2. State and local government growth appears to have finally turned a corner.3 After representing a drag on growth for several years, third quarter GDP had a sequential increase of 1.5%. This was the highest state and local growth rate since 2009, when fiscal stimulus packages supported spending.

3. We believe 2014 will show an improved outlook for capital expenditures.

Growth may come from replacement or productivity rather than new capacity.

4. Investors started purchasing equity mutual funds again in 2013.4 However, 2013 inflows are dwarfed by redemptions over the past five years.

5. The Affordable Care Act is causing dislocation in the individual health care market. Coverage in the individual market may be more expensive and have more restrictive networks.

The Big Picture

Anxiety about overbought equities and rising optimism have proliferated, as prices may have risen too high relative to corporate earnings and economic activity. We anticipate a relentless grind-higher equity market, as well as strong equity per- formance versus bonds in light of equity valuations, monetary policy, economic prospects and investor positioning.

The key to producing solid absolute returns in recent years has been maintaining an overweight to equities. Over the past year, an underweight in bonds coupled with avoidance of commodities and gold has been successful. The desire to take profits has increased over time, but we believe it is best to stay the course and watch for signs of reversal in the policy cycle and/or earnings outlook.

The rate of change in global growth has been slow to improve, but leading economic indicators are moving higher. Monetary conditions remain open-ended to stimu- late better growth. A broader, more sustainable economic expansion has occurred in recent years. A transition from a liquidity-driven to an earnings-driven backdrop and somewhat higher equity valuations is likely in the next year. Rising bond yields and increasing policy uncertainty will initially impact stocks, but we view this as temporary, not an end to the bull market. The P/E ratio for U.S. equities is neither expensive nor cheap relative to history.5 In our opinion, 2013 was the year of P/E expansion, and 2014 will depend on earnings growth to sustain the advance.

There are still areas of concern, including the cooling in housing after interest rate increases this year, entitlement growth and debt service, and a less favorable stand- ing for the U.S. in the eyes of the world. Short-term volatility could increase due to overbought equity conditions. We do not perceive that the risks are sufficient to warrant changing our reasonably constructive view.

1 Source: Morningstar Direct, as of 11/15/13. 2 Source: Bloomberg, as of 11/15/13. 3 Source: U.S. Department of Commerce Bureau of Economic Analysis, “National Income and Product Accounts Gross Domestic Product, 3rd quarter 2013 (advance estimate),” November 7, 2013, 4 Source: Investment Company Institute, “Trends in Mutual Fund Investing,” September 2013. Most recent data available, 5 Source: FactSet, as of 11/15/13. U.S. Equities represented by S&P 500 Index.

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.


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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