As the Economy Grows, Bonds Struggle and Equities Tread Water
U.S. economic data last week seemed to confirm that the country is rebounding from a weak first quarter. Manufacturing, construction, sales figures and the labor market all showed signs of improvement. U.S. equities declined, however, with the S&P 500 Index dropping 0.7%.1 The financials sector outperformed while utilities sold off sharply.1
Key Points
▪ Most data suggest U.S. and global economic growth should improve later this year.
▪ Rising bond yields and interest rate increases may cause more equity market volatility (perhaps triggering a downturn).
▪ Nevertheless, the long-term outlook is brighter, and we think investors should retain overweight positions in equities.
Rising Bond Yields Present Only a Modest Risk to Equities
So why did equity markets falter if growth is improving? The main factor concerning equity investors appears to be upward pressure on bond yields. It is not uncommon for yields to rise in advance of Federal Reserve rate hikes. It appears this is what is happening as deflation fears recede and the reality of stronger growth becomes more apparent. Rising rates and yields do present a risk to equities, and we could see a correction at any point as we approach Fed action. Longer term, however, we do not believe rising rates will derail the current bull market. See our new research paper on this topic for more detail.
Weekly Top Themes
1. Stronger jobs growth should promote more consumer spending. The May employment report was impressive. It showed 280,000 new jobs, upward revisions to previous months and an uptick in the labor participation rate.2 Wage growth also accelerated, rising 0.3% for the month and 2.3% year-over-year, the fastest rate in nearly six years.2 A healthier labor market should provide more justification for the Fed to increase interest rates later this year.
2. Manufacturing appears to be rebounding. After falling earlier in the year, the Institute for Supply Management Manufacturing Index for May exceeded expectations, marking a second month of acceleration.3 This trend suggests the worst effects of the surge in the dollar and the decline in oil may be behind us, and augers well for future earnings growth and capital spending.
3. First quarter growth may have been better than the numbers indicated. The Bureau of Economic Analysis acknowledged that statistical issues may have resulted in first quarter growth looking worse than it actually was (an issue known as “residual seasonality”). The Bureau plans to correct these problems when it revises its benchmark calculations at the end of July, which should result in an upward revision of first quarter GDP growth.
4. Domestic profits continue to outpace non-U.S. profits. In the first quarter, corporate profits sourced from the United States rose 7.7%, while profits derived from overseas earnings fell 7.2%.4 Non-U.S. growth is improving, but overseas profits still have some catching up to do.
5. Evidence is pointing to a recovery in the global economy. One month ago, half of the global purchasing managers indexes were below 50 (indicating a contraction).5 Currently only 35% are below that level, a rapid and remarkable turnaround.5 Global earnings trends are also pointing upward, with favorable revisions becoming evident in the U.S., Europe and some emerging markets.5 From a sector perspective, cyclicals such as technology are looking stronger, while defensives such as utilities are lagging.5 We believe these trends point to a global economic acceleration.
Expect Ongoing Churning Before Equities Improve
We expect equities to continue to trade sideways as investors await more clarity about the economic outlook. In our view, first quarter weakness was an anomaly, and better growth lies ahead. Global growth also appears to be improving. While risks remain (such as ongoing concerns over Greece’s debt issues), we believe the positives outweigh the negatives. The main wildcard is what will happen when the Fed raises rates, but we do not think the backdrop will turn overly punitive for stock prices.
Equities have remained remarkably resilient this year, pushing ahead modestly in the face of rising uncertainty. Volatility is likely to remain elevated, and we expect some sort of consolidation or downturn at some point. Over the longer term, however, modestly improving growth, still-accommodative global monetary policy and relatively attractive valuations argue for retaining overweight positions in equities.
1 Source: Morningstar Direct, as of 6/20/14
2 Source: Bureau of Labor Statistics
3 Source: Institute for Supply Management
4 Source: Strategas Research Partners
5 Source: Cornerstone Macro
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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