U.S. equities finished higher last week, with the S&P 500 increasing 1.4%.1 Ukraine seemed to be receding in investors’ minds. Despite the volatility and sharp increase in bond yields on Wednesday, the hawkish takeaways from the FOMC meeting were not a lingering overhang. The corporate outlook seems to be somewhat improving beyond the weather issues. The banking group rallied sharply, with a focus on the higher rate environment and favorable loan growth dynamics. Last week’s rally came despite the underperformance of some notable momentum investments, including the biotech group.
Fed Accentuates More Favorable Conditions
Equities, credit and the dollar were up last week, while bonds and commodities were down due to steady news from Ukraine and a more hawkish FOMC. Th economy slowed toward the end of 2013 and early 2014, falling short of expectations. Adverse weather conditions across the U.S. appear to account for a good portion of the slowing, with production adjustments to better control inventory levels also contributing.
Favorable underlying conditions for growth and private spending persist. After a rebound from the weather, we expect solid growth for 2014. However, it will take time to sort out the weather effects, and the outlook is more uncertain due to questions around how to interpret the recent shortfall and a tense geopolitical situation.
Weekly Top Themes
1.The FOMC emphasized that the pace of firming should be gradual, once started. We believe the bond market’s expectations of Fed policy have been too dovish, and it must eventually price in the risk of early rate hikes. The speed of that process will be directly proportional to the rate of progress in the economy.
2.Last week’s initial unemployment claims suggest most of the economic weakness over the last three months may have been due to severe winter weather. First quarter GDP should fall in the 1.5% to 2% range.2 Weather may have weighed on firstquarter GDP by about one-half of 1%.2 We estimate more than half of the lost output should be recaptured in the second and third quarters.
3.Existing home sales declined 0.4% in February.3 This was the sixth decline in seven months, and many other housing indicators have also weakened following the mid-2013 rate increase. The harsh winter may have depressed sales, but weak data preceded the unusual weather and has been widespread across regions.
4.Healthcare will certainly top the Republican agenda if they win the Senate. We view a Republican win as less than a 50% probability. If they win, they will believe they have a mandate to massively rewrite the Affordable Care Act.
Regardless, legislation could pass during President Obama’s last two years that would have important investment implications. Issues to watch: housing, finance reform, immigration reform, a budget deal and tax reform.
5.We believe the economic cycle will likely end with an asset boom and bust rather than with a more traditional real economy plus inflation over-heating. This is due to the more advanced nature of the financial cycle versus the economic cycle in the presence of unprecedented easy money.
The Big Picture
The Fed confirmed that it is somewhat more positive on growth prospects, thus slightly lifting its projected path for interest rates. The Fed will continue to react to developments and purposely lag the economic cycle. The bear market in bonds has been resting, and the next phase may be triggered by the timing of the first rate hike. The deflationary undercurrents of a slow-growing, deleveraging world imply that yields won’t rise too quickly.
We expect 2014 will be driven by a gradually improving global economy led by the U.S. Other developed economies should also slowly participate, as will parts of the emerging world. U.S. hiring and capital spending plans have held up recently, which is impressive given demand softness and the general uncertainty of the past six years. CEOs have become more upbeat in terms of capital spending and hiring intentions, despite domestic issues and angst about global demand. U.S. political tensions have eased and housing prices have improved. The tremendous pessimism since 2008 is gradually giving way to glimmers of optimism. Overall economic risk taking should gradually improve.
1 Source: Morningstar Direct, as of 3/21/14. 2 Source: Bureau of Labor Statistics. 3 Source: “February Existing Home Sales Dip To Lowest Level Since July 2012, Says NAR,” Forbes, 3/20/14.
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. Noninvestment-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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