Markets Remain in Turmoil, but Should Stabilize Eventually
Global equity markets fell last week with the S&P 500 Index down 3.4% and some non-U.S. markets declining even more.1 The sell-off is a continuing reflection of the ongoing turmoil that started a few weeks ago when China devalued its currency on August 11.
Key Points
▪ Ongoing worries about Chinese growth and Fed policy are likely to keep markets volatile for the near-term.
▪ In our view, global economic growth remains mostly in acceleration mode, which should help corporate earnings trend higher.
▪ Downside risks remain, but we expect the equity bull market will eventually resume.
Sentiment Remains Depressed but Could Improve
At its low point on August 24, the S&P 500 was down 12.5% from its high in May.1 Market psychology has clearly been damaged by the downturn and investor sentiment has soured. The bearish case is that slowing growth in China could trigger a global economic downturn at the same time the Federal Reserve may be making a mistake by lifting rates, all set against a backdrop of expensive equity markets. We think this is overly pessimistic. The sharp price decline has removed some market risk. A few days of price stability, along with neutral or better economic data, could allow investor sentiment to eventually improve, setting the stage for a resumption of the bull market.
Weekly Top Themes
1. Recent financial reforms may have exacerbated the magnitude of the sell-off. In our view, economic fundamentals remain sound and the current corrective action mostly reflects technical factors and worsening sentiment. We also believe that post-crisis reforms may be contributing to market volatility. For example, the Volcker rule prevents banks from engaging in certain types of speculative trading, which in the past acted as a stabilizing force in the markets.
2. The labor market continues to show improvement. Payrolls increased by a lessthan-expected 173,000 in August, but the data also showed significant upward revisions for July and June, as well as modest upticks in hours worked and wage levels.2 Additionally, unemployment fell to a new post-recession low of 5.1%.2
3. U.S. domestic economic conditions remain solid. Excluding the government sector (which acted as a drag during the sequester), U.S. private real gross domestic product growth has averaged 3.0% since 2010.3
4. We think there is a slightly better-than-even chance the Fed will raise rates this month. If the Fed were only focused on the health of the U.S. economy, a rate increase would be a foregone conclusion. But overseas growth and market turmoil make the case more difficult. Unless markets are rioting, we expect the Fed will enact a 25 basis point increase this month while offering a number of dovish caveats.
5. The odds of a U.S. or global recession remain low. The ongoing downturn in oil prices has triggered fears that widespread disinflation may take hold, but our view is that lower energy prices provide more economic positives than negatives. Since 1975, there have been four global recessions, each of which was preceded by a recession in the United States.4 As long as the U.S. economy remains healthy, we think it is unlikely the rest of the world will slide into recession.
An Improving Economy Should Lift Earnings and Equities
Recent turmoil in financial markets, rising pessimism about Chinese and emerging markets growth and a renewed slump in oil prices have fueled fears that the global economic recovery is faltering. While the world economy does face several challenges, we remain convinced that the United States and Europe are on an upward growth trajectory. China is a wildcard, but while growth is slowing there, it should stabilize.
We do not foresee current equity market weakness morphing into a bear market. Bear markets typically occur against a backdrop of recessions that produce significant declines in corporate earnings. Earnings have wavered this year, but we believe this is mainly due to a profit crunch in the energy sector and the sharp rise in the U.S. dollar. The negative impact of both of these factors should fade in the coming quarters, allowing earnings to improve. Additionally, monetary policy should stay accommodative even when the Fed starts raising rates. We think valuations are reasonable for equities, which leads us to retain a “pro-risk” investment view. Volatility is likely to remain elevated in the near-term, but we expect the bull market will resume, leading equities to reach new highs at some point over a six- to twelve-month time horizon.
1 Source: Morningstar Direct, as of 9/4/15
2 Source: Bureau of Labor Statistics
3 Source: Cornerstone Macro
4 Source: International Monetary Fund
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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