On the heels of a somewhat rough first quarter, many investors are questioning the state of economic growth and wondering if equities still hold value. Our view is that an improving global economy should (eventually) allow for a renewed upturn in earnings prospects, and in equity markets. As such, we believe investors should remain patient.
The Economic Environment Should Settle Down
The financial markets remain jittery, still trying to find their bearings after a massive months-long shift in the U.S. dollar, oil prices and bond yields. As has been the case since the financial crisis began, the main concern among investors is that economic growth will falter.
The main catalyst for these worries is now the strong dollar, which many fear will derail the primary global growth engine – the U.S. economy. We believe that angst about the strong U.S. dollar is overdone. Some investors fear the dollar will wreck the U.S. recovery before it lifts overseas economies. It is true that the strength of the dollar has depressed corporate earnings expectations and will likely continue to do so. However, we recommend looking past this alley of weak U.S. earnings since a strong dollar also has some positive, long-term effects, such as boosting consumer spending.
Investors are also concerned about the pending start of the Federal Reserve’s rate hike cycle. While the start of rate hikes will likely cause some temporary turbulence in financial markets, the fundamental backdrop should still be reflationary. The start of the next rate cycle is not about preventing a surge in consumer price inflation in the next year or two, but about unwinding an unprecedented monetary experiment. In other words, the Fed is not going to be raising rates to combat inflation, but rather as a reflection that the economy is strong enough that it no longer needs an emergency, zero-rate policy.
Key forward-looking economic indicators remain positive, and notwithstanding a modest pullback in March, the employment backdrop looks solid. As a result, we expect the U.S. economy to return to a solid growth path in the months ahead as the weather improves and the effects of the West Coast port strikes fade. This, in turn, should help turn around the pessimism that surrounds non-U.S. growth, which has persisted due to the implosion in oil prices (despite the fact that lower oil prices are a decisive source of stimulus for the vast majority of the world economy).
Our Pro-Growth Investment Stance Remains Unchanged
Given that stock prices have advanced in recent years while bond yields have fallen, valuations for both asset classes are less attractive than they once were. But we expect bond yields will rise when the economy improves and the Fed embarks on rate increases. We also believe equity prices will advance when an improving economy provides a renewed tailwind for earnings. As such, we recommend a pro-cyclical investment stance that is not focused on energy, favoring equities over bonds.
Many investors appear confused (or at least seem to lack conviction) in the face of the challenging investment environment since 2008. Investor behavior appears to be wildly divergent in terms of risk tolerance. It looks to us like investors are simultaneously pouring money into higher-risk secular growth areas (like biotech stocks and growth stocks) and into safe havens such as government bonds. We think such moves are unsustainable. In our view there is better value to be found in equity sectors such as health care, technology and telecommunications (while avoiding energy and other resource-related areas). Within fixed income, we also see better value in select credit sectors over government bonds.
It May Take Some Time, But Conditions Should Improve
We expect volatility to remain elevated in the coming months as the Fed debates when to start lifting rates and until the earnings outlook improves. The Fed’s rate hike cycle should be gradual (despite a historically low starting point), and we do not expect this will create a roadblock to growth for the foreseeable future. Earnings improvements could begin when companies start to benefit from falling commodity prices. Overall, valuations, positioning and leading economic indicators lead us to conclude that cyclical prospects appear favorable for equities over bonds in many cases. Market conditions may remain rocky for some time, but in the end, we think optimism will prevail.
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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