U.S. equities finished higher last week as the S&P 500 advanced 1.3%, snapping a two-week losing streak and ending at a new record high.1 Markets seemed to lack conviction, but the path of least resistance appeared skewed to the upside as momentum for the economic recovery was positive. Technology and consumer discretionary sectors led the run-up, and telecommunications and utilities lagged.2 Chinese manufacturing data surprised to the upside, while concerns about traction in the U.S. housing market recovery received a modest reprieve. Now that the Fed tapering schedule seems set, investors are turning attention to the policy normalization process and a longer-term equilibrium for the fed funds rate.
Many Investors Question the Strength of the Global Recovery
A better tone for economic data provided investors with some relief that the first quarter shortfall in economic growth was a temporary setback largely due to the severe winter weather. As equities rebounded, bond yields rose.3 A relief in equity markets did not erase questions about why U.S. Treasury yields are so low. The core of the answer is that U.S. bond yields are low because growth and inflation are low as well. As the current U.S. recovery approaches the five-year mark, traction is the weakest since World War II. The economy has grown approximately half as much as the average post-war recovery, primarily as a result of deleveraging and investor caution after the major financial crisis.4
Weekly Top Themes
1. GDP for the first quarter is projected to be revised into mildly negative territory this week. In contrast, however, data that have already been released are consistent with acceleration for the second quarter.
2. Consumer interest payments continue to trend lower, which should support better consumer spending.5
3. Bank loans increased at a 10% annual rate over the last three months, and small bank loans grew at a 13% annual rate.6 Growth in bank loans should mean that Fed tapering will not be a headwind to growth.
4. A projected increase of 0.8 points is anticipated for the Manufacturing Purchasing Managers Index (PMI™) for May.7 Overall, manufacturing reports seem generally upbeat and consistent with our view that activity will pick up in the second quarter following an inventory correction.
5. In the primary elections, voters supported the Republican candidates who should create the most competition for Democrats in the November general election. This increases the odds of Republican control of the Senate.
The Big Picture
Crosscurrents in global equity markets over the last few months continue to confound many investors. Some of these currents suggest economic activity is deteriorating, such as the decline in major government bond yields and the outperformance of defensive equity sectors over cyclical sectors (a trend that is starting to reverse). On the other hand, the bounce in commodity prices and related markets, tight spreads between corporate and government bond yields and positive trends in most global equity markets are consistent with continued economic recovery. We remain constructive on economic growth and expect the decline in yields to reverse as growth increases and as investors gain clarity on the path of Fed policy. There is some risk that the Fed’s passive acceptance of lower Treasury yields might eventually spark a sharp rebound in yields, similar to what occurred last spring when the Fed hinted at tapering.
Equity valuations are less compelling than they used to be, following the strong rally over the last two years. Corporate earnings are improving, underscoring that the equity bull market is becoming more advanced. In our view, however, equities remain attractive due to a shortage of compelling alternatives. We also expect the bear market in bonds that began in August 2012 to resume and the grinding equity bull market to persist. Leadership in equities should return to cyclical sectors.
1 Source: Morningstar Direct, as of 5/23/14. 2 Source: FactSet, as of 5/23/14. 3 Source: Morningstar Direct and Bloomberg, as of 5/23/14. 4 Source: Congressional Budget Office, “What Accounts for the Slow Growth of the Economy After the Recession?” November 2012, http://www.cbo.gov; Bureau of Economic Analysis, “Gross Domestic Product - Percent Change from Preceding Period,” 1930 - March 2014, http://bea.gov/national/index.htm#gdp. 5 Source: Federal Reserve Bank of Philadelphia, “Interest Paid by Consumers,” as of 12/31/13, most recent data available, http://www.phil.frb.org/researchand-data/real-time-center/real-time-data/data-files/PINTPAID/ 6 Source: Board of Governors of the Federal Reserve System, “Assets and Liabilities of Commercial Banks in the United States (Weekly), May 23, 2014, http://www.federalreserve.gov/releases/h8/current/ 7 Source: April 2014 Manufacturing ISM Report On Business,® May 1, 2014, http://www.ism.ws/ismreport/mfgrob.cfm.
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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