U.S. equities fell amid a relatively quiet week, with the S&P 500 Index dropping 1.1%.1 The upcoming Federal Open Market Committee (FOMC) meeting drew quite a bit of attention amid increased speculation that the Federal Reserve may start signaling its long-awaited move to increase rates. Retail sales were quite strong in August,2 and the positive reaction to Apple’s upcoming product launches dominated corporate news. The geopolitical backdrop did not seem to affect the markets, with President Obama’s statements about ISIS containing few surprises, tensions between Russia and Ukraine remaining on the back burner and reactions to the upcoming Scottish independence vote relatively muted.
The Fed May Start Signaling a Shift
All eyes will be on this week’s FOMC meeting, with many observers expecting the central bank to drop the phrase “considerable time” when discussing how long it intends to keep the fed funds rate anchored at zero. Should it do so, it would give the Fed more flexibility in its approach to monetary policy and would signal that rate increases would likely begin next year. Partially as a result of this speculation, and in part to due continuing evidence of economic strength, U.S. Treasury yields advanced last week, with the yield on the 10-year Treasury rising 17 basis points to 2.61%.3
Weekly Top Themes
1. The U.S. economy continues to be stronger than other regions. The eurozone economy remains troubled, and the turmoil in Ukraine and related sanctions against Russia are holding back growth in that region. To be sure, recently announced easing measures by the European Central Bank (ECB) should be a positive for growth, but the near-term outlook remains uncertain. At the same time, Japan’s economy is struggling. In comparison, we believe the United States is on solid footing. Employment growth is getting better, consumer and business confidence is improving and lower energy prices are acting as a tailwind.
2. Diverging monetary policies have been pushing the value of the U.S. dollar higher. At this point, most observers assume the Fed will begin increasing rates next year as the economy continues to improve. Across the Atlantic, the ECB is still ramping up its easing policies and we anticipate that the Bank of Japan will engage in additional easing measures as well. These differing stances are a main reason the U.S. dollar has experienced notable appreciation over the last few months.
3. We believe U.S. Treasury yields will continue to rise over the coming months. In our view, the jump in yields last week was not an outlier. We have been forecasting that bond markets will catch up to the reality that U.S. economic growth is accelerating. At this point, we expect the yield on the 10-year Treasury to be at 3% or higher by the end of the year.
Both the Economy and Bull Market Have Room to Run
The current U.S. economic expansion and equity bull market have been underway for five years now, but we do not believe either is approaching an endpoint. Typically, economic expansions and bull markets come to an end when inflation pressures are building, which cause the Fed to begin tightening monetary policy in an effort to curb growth. We are expecting the central bank to begin gradually tightening next year, but this move would not come as a result of higher inflation, but rather as an acknowledgement of improved growth. By that basis, the expansion and bull run are far from the endgame. We do expect to see episodes of volatility and periodic equity market setbacks, but the underlying fundamental backdrop remains supportive of economic and earnings growth, which should lead to rising equity prices.
Since the current cycle began, U.S. growth has been better than that seen in other regions and U.S. stocks have outperformed other developed markets. We do not see that changing any time soon. For the last few years, investors who have been overweighting U.S. stocks have done well, and we believe this strategy continues to make sense going forward.
1 Source: Morningstar Direct, as of 9/12/14 2 Source: U.S. Department of Commerce. 3 Source: Bloomberg, as of 9/12/14.
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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