Equities Recover Some Ground and Still May Have Room to Run
With global deflation and growth fears fading, U.S. equities snapped their four-week losing streak last week with the S&P 500 Index gaining 4.1%.1 This advance marked the largest weekly gain since January 2013.1 Following the correction from the mid-September to mid-October, the S&P 500 has now rallied 8%, leaving it only 3% from its all-time high.1
The U.S. Economy Remains Fundamentally Sound
Volatility has climbed over the past several weeks as investors have become uneasy about the state of the global economy. However, we do not believe we are seeing any sort of large-scale systemic risks in the global financial system such as what occurred in 2008 or 2011. Rather, we think the economic risks are mostly isolated to Europe and some emerging market economies.
Although there are concerns to the contrary, the U.S. economy remains in acceleration mode, and we think there is little chance that we’ll see either a recession or a deflation scare in the United States. Investors are coping with new issues that are prompting higher levels of volatility (such as Ebola and heightened geopolitical risks) but the state of the U.S. economy remains solid.
Weekly Top Themes
1. Corporate earnings are beating expectations. With over half of the companies in the S&P 500 reporting third-quarter results, earnings have been 4% better than expected, while revenues have surpassed expectations by 1%.2 We anticipate overall earnings-per-share ratios to wind up at 10% for this quarter versus expectations of 8%.2
2. Wages should rise, suggesting deflation is not a serious risk for the United States. Unemployment is falling and business leaders have been claiming that there is a shortage of skilled labor in the U.S. Together, these factors should translate into upward pressure on wages.
3. We expect higher levels of spending from the federal government in the coming years. Regardless of who wins the next presidential election, the sequester is unlikely to hold past 2016. Republicans are eager to spend more on defense, while Democrats would like to see additional spending on infrastructure and other domestic programs. Such spending would probably be offset by entitlement reform and/or tax increases.
4. The Chinese economy is likely to continue to struggle. Chinese policymakers are attempting to strike a delicate balance between maintaining growth and pursuing structural reforms. While not an impossible task, it will be difficult to rein in the country’s credit excesses without undermining growth.
Equities Have Not Reached the Top of This Bull Market
Equity markets have clawed back much of the losses they endured during the recent correction. While stocks are likely to remain volatile, we believe the recent weakness is not the start of a bear market but rather little more than a mid-cycle correction. While parts of the world are troubled (we would highlight Europe, where growth is quite weak) the United States remains solid thanks in part to an improving labor market, lower interest rates and falling energy prices. Additionally, improving corporate profit trends are a positive for the U.S. and should boost equity prices.
Sir John Templeton famously stated that “bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” The evidence we see suggests we are still far away from the “euphoria” phase that normally accompanies the top of a bull market. The U.S. financial system and housing market are healing, corporations are highly profitable and monetary policy remains accommodative. Additionally, the recent drop in oil prices and the longer-term decline in unemployment should help consumer spending. And with inflation not a near-term concern, the Federal Reserve has the flexibility it needs to proceed cautiously in tightening policy.
Equity markets will likely face ongoing near-term volatility. And at the same time, investor anxiety over issues ranging from geopolitics, Ebola and global growth is not going away. Nevertheless, we remain convinced that the bull market remains intact and that U.S. equities look attractive.
1 Source: Morningstar Direct, as of 10/24/14 2 Source: FactSet and Bloomberg
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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