U.S. equities increased 1.3% last week as the S&P surpassed the key 1850 level and pushed to new record highs.1 One favorable dynamic of the rally was the upside leadership from retail stocks, as earnings were largely ahead of expectations. Fed Chair Janet Yellen suggested concern about softer- than-expected spending in a number of recent data releases, but the bar for adjusting the tapering process has not been lowered.
Overseas Turmoil and Impact of Weather Remain Uncertain Another volatile week in Ukraine ended on a concerning note, as armed gunmen seized the two main airports. Chinese stocks were hit on continued reports of banks pulling funding from the property sector. The Chinese currency declined approximately 1% for the week, the largest weekly loss on record.
The bullish thesis for equities has been that adverse weather has caused the recent flurry of disappointing data and accompanying fears about a slowdown in growth. The impact of weather is difficult to quantify, and the headwinds of an inventory adjustment have been widely discussed, which has caused concerns that stocks may be discounting the growth backdrop in a more normalized weather environment.
Weekly Top Themes
1. The fourth quarter GDP estimate was revised down to 2.4% from 3.2%.2 Most of the downward revision was from net exports and inventories.
2. The S&P/Case-Shiller 20-City Composite Home Price Index rose 0.8% in December.3 Over the past year, the index posted strong gains of 13.4%. We anticipate gains will moderate in 2014.
3. China’s competitive position is still strong but its balance sheet has weakened. It may take several years to rationalize the borrowing that has already taken place. Whether the debt boom turns into a crisis depends partially on export demand and proactive steps taken by the central government.
4. Our view is that tax reform legislation is not likely this year.
5. Price/earnings (P/E ratio) expansion has been difficult to assess. A simple explanation is that P/E expands when inflation decelerates. Therefore, the P/E for the S&P 500 is at cycle highs while inflation (CPI) is at cycle lows.4 We will need further deceleration in inflation for P/Es to continue increasing, which we believe is unlikely.
The Big Picture
The stock market is transitioning from a macro-driven easy monetary policy environment to a more traditional, fundamental-driven environment. This is not negative, but transitions can be challenging and fundamentals currently lack clarity, which has caused volatility this year. We remain constructive on the outlook for the global economy, and maintain a moderately pro-cyclical stance for equity portfolios. Emerging market economies will continue to lag, but the underlying foundation remains relatively solid and does not threaten the U.S.-led recovery for developed markets. The weather-related disappointment should give way to renewed strength in the months ahead, driven by diminishing headwinds from fiscal drag and reflationary central bank policies. Such progress, together with improving economic backdrops in the Euro area and Japan, will provide solid support for global growth.
Stocks are no longer cheap, but neither are they expensive, and valuation risk is not elevated as long as the global recovery stays on track. Our positive macro outlook indicates that global earnings momentum will gradually strengthen and validate equity valuations. Stronger economic growth conditions coupled with Fed taper- ing will drive bond yields slowly higher over the next twelve months. Rising bond yields will diminish the income appeal of sectors with high dividend yields, such as telecommunications, utilities and consumer staples. The prospect of higher bond yields has historically translated into dividend growth outperforming dividend yield. Our sector preferences are tilted toward industries and companies with capital expenditures, as an increase in business investment is one of the characteristics of a transition to a self-sustaining economic recovery. Also, the commodity outlook remains challenged until Chinese and developed market growth accelerate, which is not yet on the horizon.
1 Source: Morningstar Direct, as of 2/28/14. 2 Source: U.S. Department of Commerce Bureau of Economic Analysis, “National Income and Product Accounts Gross Domestic Product, 4th Quarter and Annual 2013 (second estimate); February 28, 2014, http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm. 3 Source: Case-Shiller, “Home Prices Lose Momentum According to the S&P/Case-Shiller Home Price Indices,” February 25, 2014, http://us.spindices.com/index-family/real-estate/sp-case-shiller. The S&P/Case-Shiller Composite of 20 Home Price Index is a value-weighted average of the 20 metro area indices. 4 Source: FactSet and Bureau of Labor Statistics, as of 2/28/14. Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
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 adjusted 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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