Despite Escalating Volatility, U.S. Fundamentals Remain Sound
U.S. equities declined for a third straight week, with the S&P 500 Index dropping 1.2%.1 Defensive areas such as utilities and telecommunications were the best-performing sectors, while the financial sector was hit the hardest.1 Notwithstanding last week’s decision by the Swiss National Bank to remove its currency peg, the fundamental backdrop has not changed much in recent weeks. We attribute the fall in equity prices to ongoing worries about the collapse in oil prices and the ripple effect on the global financial system.
Weekly Top Themes
1. Retail sales levels fell in December, but longer-term trends remain positive. Sales excluding gasoline dropped 0.4% last month,2 but we think it would be an overreaction to suggest that the retail sector is in trouble. Over the past six and twelve months, sales ex-gas were up 4.4% and 5.3%, respectively.2
2. Inflation looks steady, but may be due to fall. The headline Consumer Price Index (CPI) fell 0.4% in December and core CPI was unchanged.3 Core CPI was up 0.8% year-over-year.3 Given the sharp decline in energy prices, we expect core CPI may turn negative in February or March.
3. We believe lower oil prices produce a net benefit to the U.S. economy. Declining oil prices help consumers and users of energy. Oil producers are hurt by this trend, but this group is relatively small. Nonfarm payrolls show 140 million people are employed in the United States, with 931,000 working in the oil and gas industry.4 In other words, less than 1% of total U.S. employment is based in the energy sector.
4. Near-term earnings trends may be disappointing, but we remain optimistic about the coming year. As the fourth quarter earnings season begins, current S&P 500 estimates are for a paltry 1% year-over-year gain, with weakness centered in the energy sector.5 Looking ahead, we believe an improving economy and healthy profit margins should help corporate earnings to rebound.
5. The U.S. dollar may be overdue for a pullback. The dollar has rallied substantially over the past few months, due to falling oil prices plus diverging economic growth and monetary policies between the United States and other countries. We think these long-term trends will persist, but some sort of nearterm consolidation or counter-rally in the dollar may occur.6. European growth remains under pressure. We expect the eurozone to continue to struggle as long as bank lending remains depressed, inflation remains close to zero and governments remain unwilling to increase spending. The growing possibility of additional easing action by the European Central Bank (ECB) will help, but likely won’t be enough to pull Europe out of its doldrums.
7. Investors have a long list of events and data to react to this week. Earnings results will get their share of attention, and this week also features a rash of Chinese economic data, the President’s State of the Union address, an ECB meeting and elections in Greece.
Sentiment Falters, Yet Equities Still Look Attractive
The sharp decline in oil has contributed to a fall in equity prices and in bond yields, as it has sparked global deflation fears and undermined confidence in the global economy. The fundamental supply and demand factors behind falling prices are real, but we believe prices may have overshot and the current turmoil should diminish. The souring of investment sentiment seems out of sync with increasing evidence of economic acceleration.
The pickup in volatility is unnerving, but we encourage investors to ride out the equity market turbulence. Those with longer-term horizons may want to consider using periods of weakness to add to positions as well. We expect the coming year to be a positive one for global equities in both absolute terms and relative to Treasuries. We think both the economy and corporate earnings are strengthening, and global monetary policy remains supportive. Commodity price volatility remains a risk, and equities are likely to remain vulnerable until oil prices stabilize. We think equities will be able to overcome this risk.
1 Source: Morningstar Direct, as of 1/16/15 2 Source: U.S. Department of Commerce 3 Source: Bureau of Labor Statistics 4 Source: Deutsche Bank Research 5 Source: MRB Partners
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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