Investors continued to focus on global monetary policy last week. The divergence between the start of the European Central Bank’s quantitative easing program and the pending shift in the Federal Reserve’s policy stance caused the euro to fall, the U.S. dollar to rally and acted as a drag on U.S. equities.1 Concerns over a weakening corporate earnings environment acted as an additional headwind for stock prices. the S&P 500 Index declined 0.8% for the week.1
Weekly Top Themes
- Retail sales figures declined, but the outlook remains solid. U.S. retail sales fell for a third consecutive month, dropping 0.6% in February.2 This marks the first time since 2012 that we have seen a three-month downturn.2 Looking ahead, we believe a combination of solid employment gains, rising income levels and improving consumer confidence should provide a boost to spending.
- Last week’s stress test results are a positive sign for the banking sector. All 31 of the largest U.S. banks passed the Federal Reserve’s annual regulatory test for the first time since they were introduced in 2008.3 It has taken nearly eight years, but in some ways this could be seen as marking an end of the financial crisis that began in 2007.
- Wage increases appear to be on the horizon. The latest survey from the National Federation of Independent Business shows that more small businesses than not are planning to hire workers.4 This trend, combined with the fact that the unemployment rate has fallen to 5.5%,5 suggests that we should soon see an uptick in wage inflation.
- Corporate earnings are being buffeted by a number of crosscurrents. Citigroup Global Capital Markets data shows how the current environment is affecting earnings. On the negative side, every 10% appreciation of the U.S. dollar translates into between a 2% and 3% decline in earnings-per-share (ESP) growth and every 10% drop in oil prices drags down growth by 1%.6 On the positive side, each 1% increase in gross domestic product growth boosts EPS growth by 4%.6
- A multitude of factors can be blamed for the recent downturn in equity prices. We would cite a growing belief that the Fed is on the verge of increasing rates, the beginning of the ECB’s easing program, concerns over Greece’s debt restructuring, the rising dollar and a weaker earnings environment.
Equities Should Absorb a Shift in Fed Policy
At this point, it seems almost a foregone conclusion that the Fed will begin increasing rates at some point in 2015. When it does act, we think the Fed will raise rates slowly and carefully. Even with modest rate increases, monetary policy will remain at accommodative levels. It is normal to see heightened volatility in advance of Fed action, and market action is unlikely to deter the Fed absent a more severe downturn in equities and/or a sharp spike in bond yields.
This pending shift, along with easing elsewhere in the world, has caused the U.S. dollar to appreciate rapidly. A stronger dollar has some negative effects, but ultimately is a net positive for the global economy. The sharp increase has hurt corporate earnings, but should eventually help the U.S. economy since it provides a boost to consumer spending. At the same time, an appreciating dollar is a plus for the eurozone, Japan and export-oriented emerging markets and should help promote a self-reinforcing global recovery.
Uncertainty over exactly when the Fed will act and how fast it will move when it does so has caused a rise in bond market volatility, and we believe a shift in the fed funds rate is likely to act as a drag on many areas of the fixed income market. Equity markets have also been under pressure, but we believe equities should be able to weather Fed rate increases. Corporate earnings are providing less of a tailwind than they once were, but improving global economic growth and policy easing elsewhere in the world should continue to support risk assets. As such, we continue to advocate a pro-growth investment stance and believe investors should continue to hold overweight positions in equities.
1 Source: Morningstar Direct and Bloomberg, as of 3/13/15 2 Source: U.S. Commerce Department 3 Source: Federal Reserve 4 Source: NFIB 5 Source: Bureau of Labor Statistics 6 Source: Citigroup Global Capital Markets
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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