Last week U.S. equities advanced as the S&P 500 increased by 1.3%.1 We have been amazed by the market’s ability to continue to rally in an environment in which sales growth has been anemic and earnings gains have been largely based on companies’ abilities to manage margins and utilize financial engineering.
Awaiting the Self-Reinforcing Expansion
Despite a lackluster economic and profit backdrop, there are growing expectations that the Fed will continue with open liquidity taps, intensifying the search for yield and forcing investors into equities. It seems that corporations are taking advantage of this yield hunger by issuing debt, levering up their balance sheets and returning cash to shareholders. A greater risk for the global economy appears to be deflation. While quantitative easing by the Fed and other central banks may eventually result in higher final goods prices, a more immediate result may be higher prices for risky financial assets, especially equities.
Another critical issue is whether growth will falter again. We believe the chance of a growth relapse is relatively low. The housing recovery alone is only a small plus for the overall economy. Its effect on consumption, government revenues, improved collateral values, and a slowly-healing monetary transmission mechanism will help create a self-reinforcing expansion, although we believe the recovery could remain less vigorous than in past cycles. Until housing reached its trough, the economy could not begin to recover, and now further housing price gains and sales will continue to provide a modest economic tailwind.
Weekly Top Themes
- Initial filings for jobless claims declined again, setting a new low for the cycle:2 The jobless claims fell by 4,000 for the week ended May 4, 2013. Since claims have now fallen three weeks in a row, this continues to send a reassuring signal about the health of the labor market. If claims can hold near current levels or fall further, we would anticipate a solid increase in private sector job creation.
- The Fed’s latest Senior Loan Officer Opinion Survey showed easing in lending standards and increases in demand for lending categories:3 The report was somewhat of an improvement, but reflects continued modest economic growth. The Fed survey tends to have a one-year lead on S&P revenues.
- The macro tail risk from Washington continues to decline as the debt ceiling breach has moved from July to most likely October :4 The improvement is a result of higher than expected receipts from the expiration of the payroll tax credit and the tax raises associated with the fiscal cliff deal. This is likely to provide a much longer runway than was previously anticipated, and U.S. political issues should have less of an impact during the second and third quarters.
The Big Picture
We believe the market is suggesting improvement in the economy, not only by appreciation but also by internal action. In our opinion, factors generally associated with a cyclical upswing, such as beta and leverage, have begun to outperform for the first time this year, while those offering stability are starting to lose some steam. The next part of the story unfolded at the sector level two weeks ago, when cyclicals began to outperform while defensive sectors started to falter. For example, information technology, energy, financials, industrials and materials are all outperforming the broad market while consumer staples, utilities, health care and telecom are lagging.5
For equities, we believe the trend continues to be upward. For the bond markets, we expect a continued upward tilt in yields. Commodities are likely to continue to struggle until global economic activity is more robust. Higher dividend stocks and defensive stocks have become relatively expensive, and in our view many cyclical companies and emerging equity markets offer good value in a low growth world. We expect this shift to continue only if global economic growth improves, and more evidence is needed for those trends to continue.
Beta is a measure of the volatility of a portfolio relative to the overall market. A beta less than 1.0 indicates lower risk than the market; a beta greater than 1.0 indicates higher risk than the market.
Leverage is created when a portfolio has investment exposure (both reward and/or risk) equivalent to more than 100% of the investment capital.
1 Source: Morningstar Direct, as of 5/10/13. 2 Source: Bureau of Economic Analysis, “The Employment Situation,” May 3, 2013, http://www.bls.gov/news.release/empsit.nr0.htm. 3 Source: The Fed-eral Reserve Board, “The April 2013 Senior Loan Officer Opinion Survey on Bank Lending Practices, April 2013, http://www.federalreserve.gov/boarddocs/snloansurvey/201305/default.htm. 4 Source:New York Times, “House Vote on Debt Ceiling Gives Priority to Creditors,” May 9, 2013, http://www.nytimes.com/2013/05/10/us/politics/house-votes-to-give-creditors-priority-if-debt-ceiling-is- breached.html. 5 Source: FactSet, as of 5/10/13.
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. 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 conditionsand 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 interestrates rise, bond prices fall. Non-investment-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. Pastperformance 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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