U.S. equities were little changed last week, with the S&P 500 declining 0.1%.1 Stocks posted gains early in the week before falling on Thursday and Friday after the Federal Reserve announced it would hold rates steady. For the week, utilities, consumer staples and health care outperformed, while materials, telecommunications and financials came under pressure.1
Key Points
▪ The Fed’s decision to keep rates on hold may have been a mistake and could act as a headwind for equities.
▪ While investors are focused on global growth risks, we expect the world economy to improve, led by the United States.
▪ Markets require some time to heal, but should eventually start to trend higher.
The Fed’s Decision Is a Negative for Equities
It is not surprising that the Fed did not raise rates, but the reasons it cited were unexpected. Rather than focusing on the labor market (as it had in previous meetings), the Fed pointed to a lack of inflation, the strength of the dollar and global economic and financial issues as the reasons for its policy decisions. In making this shift, the Fed effectively moved the goalposts, indicating that the labor market and economy still aren’t strong enough to justify even a single rate increase. In our view, the Fed’s statement and lack of action increases uncertainty about the direction of monetary policy and acts as a net negative for risk assets, including equities.
Weekly Top Themes
1. August retail sales data were favorable and point to stronger consumer spending. The 0.2% increase in total sales fell slightly short of expectations, “but the 0.4% increase in core spending was better than anticipated.2 We expect stronger retail sales should push real growth in consumer spending above 3% for the third quarter.
2. Non-U.S. growth remains uneven. China’s economy is weakening, Russia’s recession shows no sign of abating and Brazil is facing serious financial and political problems. The eurozone has been improving, but business confidence and the refugee crisis are concerns. The U.S. economy remains sound, but overseas headwinds may undermine domestic confidence.
3. Deteriorating credit conditions could act as a headwind for equities. We think credit spreads have been widening over the past few months for three reasons: weakening credit fundamentals, deflationary pressures from emerging markets and concerns over Fed tightening. If credit markets don’t improve in the coming months, equity rallies may be difficult to maintain.
4. Equity volatility may persist, but markets have been calming. Markets are showing some signs of stability and trading appears to be normalizing as equity prices have edged higher. Clearly, sentiment remains depressed. While we will likely see additional volatility in the short-term, conditions may be improving.
Equities Should Advance Once Markets Have Time to Heal
Fed policy has been the most debated topic of the year, largely since the U.S. economy is accelerating while inflationary pressures remain almost nonexistent. With the Fed on hold, investors remain understandably confused and nervous about what policy means for the markets and economy. Yet the irony is that we think small and measured rate increases would largely be a non-event. A modest increase in rates would still leave policy accommodative. And in our view, neither the economy nor the equity markets still require a zero-interest-rate stance to grow. By not moving, the Fed may risk being unable to fully normalize rates during this economic expansion due to its delayed start and ongoing global vulnerabilities.
Global growth has softened materially this year, largely due to weakness in China and a downturn in global trade. At some point we expect these issues to stabilize, but we think they represent the most serious risks to the world economy. Current conditions are not as bad as many perceive, and we expect global growth to improve, led by ongoing acceleration in the United States. However, we expect rough times for commodity-based economies.
The S&P 500 remains in a trading range between 1,867 (the low in August) and 2,050 (the low end of the pre-correction range).1 For the time being, we expect sideways volatility to persist as markets heal. Looking ahead, however, we expect to see improvements. Specifically, on a three- to six-month time horizon, we would make the following forecast: 2016 earnings-per-share for the S&P 500 should be around $128 and the forward price/earnings ratio should be close to 16X. Multiplying those two numbers would imply an S&P 500 Index price level of around 2,050.3
1 Source: Morningstar Direct, as of 9/18/15
2 Source: Commerce Department.
3 On 9/18/15, the S&P 500 Index closed at 1,958 (Source: Bloomberg)
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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