Last week featured some positive economic news, but equity markets sank nonetheless, with the S&P 500 Index falling 1.3%.1 On the bright side, we saw some strong data from the housing market and an upward revision to second-quarter gross domestic product growth (GDP). Those factors were overwhelmed by the negatives of heightened geopolitical tensions, renewed concerns over monetary policy, new rules surrounding overseas corporate taxes and the continued strengthening of the U.S. dollar (which could negatively affect exports). Most cyclical sectors underperformed defensive areas of the market, a trend we have seen through most of this year.1
Solid Earnings Growth May Drive Further Equity Gains
Different factors appear to be driving this bull market higher versus what we have seen in previous years. Last year, investors had a sense that risks were fading, which prompted them to move from asset classes like cash into equities.
This year, we see that trend vanishing, suggesting markets will require stronger fundamentals, particularly solid earnings growth, to make additional gains. Fortunately, we think that improving economic growth should mean decent earnings should continue.
Weekly Top Themes
1. U.S. economic growth continues to improve. Last week’s upward revision to second-quarter GDP was driven largely by an increase in capital expenditures, which increased by 9.7% compared to the 5.5% originally reported.2 It appears to us that third quarter growth is trending somewhere between 3% and 3.5%.
2. New home sales surprised to the upside. Sales in August soared by 18%, the largest month-over-month gain since 1991.2 Although new home sales tend to be volatile and have previously been trending lower, this increase is a welcome positive surprise.
3. Tax policy changes will slow corporate inversions, but shouldn’t reverse the trend. We think the changes announced last week by the Treasury Department will make it slightly more difficult for U.S. corporations to incorporate overseas, but they are not significant enough to halt the practice. The new rules also highlight the possibility for additional tax reform. Should Republicans capture the U.S. Senate in the upcoming elections, we think the odds for some sort broader tax reform would climb.
4. U.S. multinational companies could face earnings pressure. While U.S. manufacturing data have been impressive, other markets have continued to struggle. This trend, combined with a stronger U.S. dollar, could put pressure on U.S. multinational companies.
5. We do not expect Federal Reserve rate increases any time soon, but when they start, they could be faster than many think. We anticipate the first Fed rate increase will come in the first half of next year. However, the Fed would have waited so long by that point to begin rate increases, so the pace of hikes from 0% may be quicker than many expect.
Expect Choppy (but Still Rising) Equity Markets
Improving U.S. economic growth and a gradual healing throughout the world should be supportive for corporate earnings, as well as equities. Geopolitical tensions are the chief threat to this view, but we believe it is unlikely that turmoil would escalate to the point of jeopardizing the global recovery. Rising interest rates should also be considered, but the Fed is proceeding cautiously.
The path ahead for equity markets is likely to be choppier than in previous years, and equities are more expensive. Nevertheless, we believe stocks offer solid longterm prospects and look more attractive than cash or many areas of the bond market. Volatility is likely to remain elevated, but we view near-term corrections as opportunities for long-term investors to increase allocations given this supportive backdrop.
1 Source: Morningstar Direct, as of 9/26/14 2 Source: U.S. Department of Commerce
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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