Equity Losses Continue, but This Correction May Be Ending
U.S. equities endured a high degree of volatility last week, dropping sharply before recovering some of their losses. For the week, the S&P 500 Index lost 1.0%, marking the fourth consecutive down week for stocks.1 Global growth concerns and oversold conditions contributed to the downturn, as investors generally focused on large-scale macro issues and risks rather than on fundamentals and corporate earnings. Defensive sectors such as health care and consumer staples drove the market lower, while a bounce in cyclical stocks helped industrials and materials outperform.1 Small cap stocks rallied and outperformed large caps as they snapped a six-week losing streak.1
Market Technicals Turned Positive Amid High Volatility
Much of last week’s volatility occurred on Wednesday when equities opened by plummeting close to 2.5% amid huge volume.1 We estimate as much trading occurred in the opening half-hour as we see in a typical day. At the same time, the yield on the 10-year Treasury fell from 2.20% on Tuesday to 1.86% on Wednesday morning.1 Such moves represented panic selling in equities and panic buying in bonds as investors fled into “safe haven” assets.
Importantly, however, markets recovered some of their early-day losses before experiencing another pullback later on Wednesday. Although the afternoon decline was greater than that morning’s, it was more orderly with less trading volume. This suggests we may have been seeing the beginning of the end of corrective action.
Thursday saw an additional test of the market lows, but investors began buying shares back, which was another good sign. More importantly, market factors showed at least some degree of risk appetite returning in the second half of the week. Cyclical sectors outperformed defensive sectors, energy stocks recovered, commodity prices rose and equities saw notable advances on Friday.1 We view all of these factors as further evidence that the correction may be in the process of ending.
We Believe This Equity Bull Market Should Persist
To put current market action into perspective, this is now the fourth correction we have seen so far this year. Equities fell 7% in January, 4% in April and 5% in August. If the bottom seen on Wednesday holds (1,820 for the S&P 500 Index) that would represent a 10% decline from the intraday high reached on September 19.1
Despite the most recent decline, however, we believe fundamentals have not changed significantly. The proximate cause for the current pullback appears to be heightened concerns about European growth and deflation, but these issues are not new. Likewise, concerns over Federal Reserve policy, geopolitics and corporate earnings have been present for months. In our view, the current correction has been more technical in nature. Markets were overdue for a 10% correction and investors seem to be responding to the same fears that have been around for some time.
We remain cautiously optimistic about the state of the U.S. economy. If anything, recent trends could help. Energy prices have fallen sharply over the past few weeks and months, which acts as a de-facto tax cut for consumers. And lower interest rates should help the housing market. As long as U.S. growth holds up, corporate earnings should be decent enough, allowing equity markets to grind higher.
In addition, equity markets tend to perform quite well in the aftermath of midterm elections (often following a difficult September/October period). In fact, since 1950, the S&P 500 Index experienced positive returns in every six-month period following the last 16 mid-term elections, with an average gain of 16%.2
At the end of the day, we still believe that equities appear attractive, especially relative to Treasuries. At present, the dividend yield of the S&P 500 Index is 2.1%, which is pretty close to the yield on the 10-year Treasury.1 This means that stocks are producing roughly the same current income as government bonds, but stocks also offer the prospects for growth and dividend increases, which bonds do not.
Looking ahead, we expect volatility to remain relatively high and markets could again test the bottoms seen last week. But evidence suggests it is more likely than not that this current correction is ending and that the long-term prospects for equities remain sound.
1 Source: Morningstar Direct, and Bloomberg as of 10/17/14 2 Source: BCA Research
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.
©2014 Nuveen Investments, Inc. All rights reserved.
GPE-BDCOMM3-1014P 3805-INV-W10/15