A rash of positive news propelled stock prices higher for the fourth consecutive week, marking the longest winning streak for equities since last November.1 The S&P 500 Index pushed above the 2,000 level for the first time as it gained 0.8% for the week.1 The good news included a surprise upward revision to second-quarter U.S. gross domestic product growth from 4.0% to 4.2%2 and consumer confidence readings that rose to a seven-year high.3 The Russian military incursion into Ukraine did cause some market jitters, but was not enough to derail the upward trend.
Accommodative Policy Should Keep the Economy Growing
It seems clear to us that U.S. growth is in the process of shifting to a faster pace than in recent years. Consumer confidence is improving while business confidence and business investment are rising, thanks largely to improving corporate profits. Outside of the U.S., however, many regions (particularly the eurozone) are still struggling. Ironically, these economic problems are contributing to U.S. growth via lower oil prices, lower interest rates and a stronger U.S. dollar.
One of the primary factors contributing to growth has been the policies of the Federal Reserve and other central banks. Around the world, policymakers have been keenly focused on stimulating growth, and after the scares of the financial crisis central banks will be extremely cautious about when and how they will moderate their accommodative measures. In our view, the Fed and other central banks will retain their pro-growth policy stances until it is abundantly clear that economic risks are significantly lower.
At some point, the Fed will begin to increase interest rates, but such an event is still months away. For now, Fed policy remains easy and other central banks are ramping up their own stimulus packages, which should further boost the world economy. Additionally, we believe the first Fed rate hike will occur only when conditions have improved to the point that higher rates are warranted. In sum, we expect the global and U.S. economies to advance by approximately 3% or more over the coming 12 to 18 months as we see a modest uptick in inflation and gradual Fed normalization.
Equity and Bond Markets Show Diverging Signals
One of the reasons for skepticism over the state of the economy is that with yields so stubbornly low, the bond market is forecasting stagnation and a deflationary environment. To some extent, U.S. bond yields are being held back in sympathy with the implosion of euro area yields, which have collapsed amid weakening growth and deflationary threats.
In contrast, with equities hitting new highs, stocks are clearly signaling stronger growth. In our view, the equity markets are more likely to be correct. European growth is probably not as bad as eurozone bonds would have it, and at some point we expect U.S. bond markets will catch up with the reality of improving growth. As such, we expect global bond yields should reverse course and begin to move higher.
Despite Downside Risks, Equities Can Move Higher
The current U.S. economic expansion and equity bull market are past the five-year mark and U.S. stock prices have tripled since their March 2009 lows.4 Given that run, it’s not surprising that many are looking for reasons why an economic downturn or a market correction could be imminent. Some observers point to what they believe are stretched valuations (a view we do not share) and others highlight a growing list of current and potential geopolitical hot spots (situations we agree could cause heightened volatility).
Our view? We are at least as constructive as the consensus if not more so about the outlook for the economy and for equities. Inflation is stable, central bank policies are still promoting growth, corporate earnings are improving and forward-looking indicators suggest the economy may be moving into a higher gear.
The current bull market is starting to grow a bit tired and we think volatility is likely to rise. We also believe gains will be tougher to come by, but we still have a positive outlook toward equities. Absent a recession (and we simply don’t see the ingredients for one being even remotely present), we expect equities will be able to make further gains.
1 Source: Morningstar Direct, as of 8/29/14 2 Source: Bureau of Economic Analysis. 3 Source: Thompson Reuters/University of Michigan Survey of Consumers. 4 Source: Morningstar Direct, as of 8/29/14. Data is based on the S&P 500 Index intraday low of 666 reached in March 2009 versus the 8/29/14 closing level of 2,004.
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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