Robert C. Doll, CFA
Senior Portfolio Manager,
Chief Equity Strategist
Nuveen Asset Management, LLC

Weekly Investment Commentary

A Relatively Dovish Fed Statement Helps Equities
Recover Ground


March 23, 2015
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Key Points

  • A more dovish-than-expected Fed statement pushed back expectations for rate increases and provided a boost to equity prices.
  • We continue to believe the Fed will begin increasing rates in 2015.
  • Global policy remains supportive for equities and we continue to have a pro-growth investment bias.

Last week featured some disappointing economic data and further downward revisions of corporate earnings estimates, but investors focused heavily on last week’s Federal Reserve policy meeting. The Fed’s statement was more dovish than expected, and investors interpreted the comments as an indication that rate increases would not happen as soon as some anticipated. As a result, the U.S. dollar lost some ground and equities rallied, with the S&P 500 Index snapping a three-week losing streak to gain 2.7%.1 Health care was the best-performing sector, while materials was the only area of the market to end the week in the red.1

 

We Still Expect Rate Increases Will Begin in 2015

The main headline from the Fed’s statement was the removal of the word “patient” when discussing the path toward rate increases, but almost every other aspect signaled no immediate hurry to act. The Fed indicated that it still saw some slack in the labor market and noted that inflationary pressures remain absent.

Our view is the Fed is reacting to the strong upward trend of the dollar, muted wage increases and signs that economic growth has become sluggish. Federal Reserve officials understandably want to retain some flexibility, but we believe rate increases at some point over the coming months are almost inevitable. Our best guess would be that the Fed will enact its first rate increase at its September policy meeting, rather than in June as many had previously anticipated.

 

Weekly Top Themes

  1. The manufacturing sector has been struggling. Industrial production increased at a disappointing 0.1% rate in February, while manufacturing output fell 0.2%.2 Some of the weakness can be attributed to temporary factors such as the harsh winter weather and the West Coast port strike, but we also believe that the strength in the dollar has been hurting manufacturing.
  2. Lower oil prices and the stronger dollar bring both positives and negatives. Specifically, we believe that while these trends are hurting U.S. corporate earnings results and expectations, they are also net positives for the U.S. economy.
  3. We expect several market trends to continue. The months-long themes of falling commodity prices and a rising U.S. dollar may be taking a break, but those trends are probably not over. At the same time, we expect equities will outperform bonds in the coming months and European equity strength will persist in the near-term.
 

The Global Economy Should Gradually Accelerate, Providing a Tailwind for Stock Prices

It appears the world economy may be at the beginning of a gradual leadership transition from the U.S. to non-U.S. markets. With the Fed likely to begin increasing rates later this year, the reflation banner is being passed from the U.S. to the euro area and Japan. Many emerging market economies should also benefit from interest rate cuts, but it will take some time before economic growth accelerates.

Reflationary trends have been a critical driver of equity market performance in recent years and we do not believe that the era of reflation is over. Many central banks are still in the early stages of easing. In the U.S., Fed policy remains highly accommodative and even when the Fed finally does begin raising rates, it will be starting from such a low level that monetary policy should remain supportive for equities for some time.

Given this backdrop, we continue to believe that equities look attractive and expect they should benefit from a gradual acceleration in global growth. With commodity prices likely to remain soft, we tend to prefer commodity users rather than producers, and have a bias toward the non-commodity cyclical sectors. Over the coming months, we expect upward pressure on the value of the dollar to continue, but do not anticipate the dollar’s rise will continue at the same breakneck pace we have seen in recent months. At the same time, we expect to see a gradual rise in global bond yields as the Fed approaches the start of interest rate increases.

 

1 Source: Morningstar Direct, as of 3/20/15
2 Source: Federal Reserve



 

Last Week's Commentary

Monetary Policy Concerns Continue to Weigh on Markets


March 16, 2015
 

Key Points

  • Fed policy questions have been driving volatility in both equity and bond markets.
  • The rising value of the U.S. dollar has put pressure on earnings and has contributed to the market downturn, but ultimately is a positive for the global economy.
  • Equity markets should be able to withstand Fed rate increases, and our pro-growth investment view remains unchanged.

Investors continued to focus on global monetary policy last week. The divergence between the start of the European Central Bank’s quantitative easing program and the pending shift in the Federal Reserve’s policy stance caused the euro to fall, the U.S. dollar to rally and acted as a drag on U.S. equities.1 Concerns over a weakening corporate earnings environment acted as an additional headwind for stock prices. The S&P 500 Index declined 0.8% for the week.1

 

Weekly Top Themes

  1. Retail sales figures declined, but the outlook remains solid. U.S. retail sales fell for a third consecutive month, dropping 0.6% in February.2 This marks the first time since 2012 that we have seen a three-month downturn.2 Looking ahead, we believe a combination of solid employment gains, rising income levels and improving consumer confidence should provide a boost to spending.
  2. Last week’s stress test results are a positive sign for the banking sector. All 31 of the largest U.S. banks passed the Federal Reserve's annual regulatory test for the first time since they were introduced in 2008.3 It has taken nearly eight years, but in some ways this could be seen as marking an end of the financial crisis that began in 2007.
  3. Wage increases appear to be on the horizon. The latest survey from the National Federation of Independent Business shows that more small businesses than not are planning to hire workers.4 This trend, combined with the fact that the unemployment rate has fallen to 5.5%,5 suggests that we should soon see an uptick in wage inflation.
  4. Corporate earnings are being buffeted by a number of crosscurrents. Citigroup Global Capital Markets data shows how the current environment is affecting earnings. On the negative side, every 10% appreciation of the U.S. dollar translates into between a 2% and 3% decline in earnings-per-share (ESP) growth and every 10% drop in oil prices drags down growth by 1%.6 On the positive side, each 1% increase in gross domestic product growth boosts EPS growth by 4%.6
  5. A multitude of factors can be blamed for the recent downturn in equity prices. We would cite a growing belief that the Fed is on the verge of increasing rates, the beginning of the ECB’s easing program, concerns over Greece’s debt restructuring, the rising dollar and a weaker earnings environment.
 

Equities Should Absorb a Shift in Fed Policy

At this point, it seems almost a foregone conclusion that the Fed will begin increasing rates at some point in 2015. When it does act, we think the Fed will raise rates slowly and carefully. Even with modest rate increases, monetary policy will remain at accommodative levels. It is normal to see heightened volatility in advance of Fed action, and market action is unlikely to deter the Fed absent a more severe downturn in equities and/or a sharp spike in bond yields.

This pending shift, along with easing elsewhere in the world, has caused the U.S. dollar to appreciate rapidly. A stronger dollar has some negative effects, but ultimately is a net positive for the global economy. The sharp increase has hurt corporate earnings, but should eventually help the U.S. economy since it provides a boost to consumer spending. At the same time, an appreciating dollar is a plus for the eurozone, Japan and export-oriented emerging markets and should help promote a self-reinforcing global recovery.

Uncertainty over exactly when the Fed will act and how fast it will move when it does so has caused a rise in bond market volatility, and we believe a shift in the fed funds rate is likely to act as a drag on many areas of the fixed income market. Equity markets have also been under pressure, but we believe equities should be able to weather Fed rate increases. Corporate earnings are providing less of a tailwind than they once were, but improving global economic growth and policy easing elsewhere in the world should continue to support risk assets. As such, we continue to advocate a pro-growth investment stance and believe investors should continue to hold overweight positions in equities.

 

1 Source: Morningstar Direct and Bloomberg, as of 3/13/15
2 Source: U.S. Commerce Department
3 Source: Federal Reserve
4 Source: NFIB
5 Source: Bureau of Labor Statistics
6 Source: Citigroup Global Capital Markets



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A Word on Risk
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. 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. Past performance is no guarantee of future results. Certain information contained herein is based upon third-party sources, which we believe to be reliable, but is not guaranteed for accuracy or completeness.

Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.

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