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

Weekly Investment Commentary

Earnings Growth Improves While Equities Tread Water

July 28, 2014
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Markets could have reacted to several events last week, but equities traded without much conviction. Solid corporate earnings results received their fair share of attention, and while prices of individual stocks moved based on the results, this did not carry through to the broader market. Likewise, geopolitical tensions escalated, but without any sustained effect on sentiment. The S&P 500 Index was flat for the week as it remains close to its all-time high.1 The energy, technology and health care sectors led the way, while industrials and consumer sectors lagged.1


Earnings Trends Improve, as Should Economic Growth

Close to half of the S&P 500 companies have now reported second quarter earnings and results have generally been beating expectations. So far, 75% of companies have exceeded growth expectations by an average of 6%. Revenues have surpassed expectations by 67%, well above the 53% rate reported in the first quarter.2

Later this week, we will see the first estimate of second quarter U.S. gross domestic product growth, and we are expecting a solid number. Following a sharp contraction in the first quarter, we are calling for U.S. and global growth to average above 3% for the remainder of the year.


Weekly Top Themes

  1. Initial jobless claims declined and reached a new low for the current economic recovery.3 Along with other employment improvements, this data points to the continuing strengthening of the labor market.
  2. Inflation is rising modestly. The headline Consumer Price Index increased 0.3% in June, with the year-over-year figure advancing 2.1% (core CPI was up 1.9%).4 Our view is that inflation is moving from very low to merely low. Inflation is now at a level that we believe is a positive for equities, but that could become a negative for bonds.
  3. Domestically-oriented companies continue to show better earnings trends. For the second quarter, earnings growth expectations for these companies are 11.1%, compared to 6.3% for globally-oriented companies.2 Should these numbers hold, this would mark the ninth consecutive quarter of such a trend.
  4. We expect this week’s FOMC meeting to be relatively uneventful. The Fed will likely taper its asset purchases by another $10 billion and signal that it will maintain its accommodative policy stance. Beyond the headlines, however, we anticipate an active debate around slack in the economy, the risks of inflation and how the Fed should proceed with its exit strategy.
  5. The federal budget deficit should continue to fall in the near term. The deficit peaked at just over 10% of U.S. GDP at the end of 2009, but has since fallen to 3%.5 We expect the deficit will continue to decline for the next two or three years, but longer-term issues such as entitlement reform will need to be addressed.

Improving Economy and Earnings Should Help Equity Prices Climb

The U.S. economy shows signs of a broad-based acceleration based on recent data and leading indicators. On a global basis, geopolitical issues could cause an economic drag, particularly in Europe, but improving growth in both the U.S. and China should help offset any weakness. Along with an accelerating economy, earnings have also been improving, and together these factors should provide a tailwind for equity prices.

Given the strong run up in stock prices over the past few years, we also believe that the economy and earnings still have some catching up to do with equities. On top of that, it is reasonable to wonder whether years of extremely stimulative monetary policy and low inflation have caused financial asset prices to rise too far, too quickly.

All told, we believe there probably are some distortions in asset prices, but the risks seem more present in government bond markets than they do in equities. Following the one-sided gains of the past few years, stocks do seem overdue for a correction. But absent a sharp increase in bond yields or rising expectations of an imminent Fed rate hike, we think the risks of a sustained pullback are quite low.


1 Source: Morningstar Direct, as of 7/25/14.
2 Source: RBC Capital Markets.
3 Source: U.S. Department of Labor
4 Source: Bureau of Labor Statistics
5 Source: Cornerstone Macro Research and the U.S. Congressional Budget Office.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy.


Last Week's Commentary

Geopolitics Spark Volatility, but Earnings Should Help Equities

July 21, 2014

Last week’s market action was notable because of the pickup in volatility. Stocks fell sharply on Thursday following the downing of the Malaysia Airlines flight in eastern Ukraine, but bounced back on Friday. In addition, rising tensions in the Middle East acted as a drag on risk asset prices. In contrast, solid earnings results and a continued advance in merger and acquisition activity acted as tailwinds. In the end, the positive factors won out, with the S&P 500 Index posting a 0.6% gain for the week.1


Three Scenarios: Where Are Markets Headed?

Equity market valuations have been rising over the past few years, and since higher valuations are associated with lower long-term returns, it is fair to wonder where stock prices may be heading from here. We would forecast three scenarios, from most to least likely:

1) Earnings accelerate, and equities grow into their higher valuations.

2) We witness uneven economic and earnings growth, which slows the Fed normalization process, and markets grind higher.

3) A significant market pullback occurs, caused by sharply rising bond yields or substantial earnings disappointments.


Weekly Top Themes

  1. The situation in Ukraine could cause additional volatility. The airline downing occurred just hours after new sanctions from the U.S. and European Union against Russia were announced, resulting in a significant increase in tensions. These events will likely continue to result in escalating market volatility.
  2. Corporate earnings should accelerate. After growing 5% in the first quarter, expectations for second quarter earnings growth are around 6%.2 We think these expectations are too soft for a couple of reasons. First, actual earnings have historically beaten expectations by about 3%.2 Second, expectations for the financial sector are quite weak and may be dragging down forecasts for the rest of the market. We expect double-digit nonfinancial earnings growth for the second quarter and also believe results will continue to be strong in the following quarters.
  3. Falling oil prices are a boon for equity markets. It now appears that the recent spike in oil prices was a temporary event caused by the turmoil in Iraq. In our view, unless we see a significant acceleration in Chinese economic growth, oil prices should remain relatively well-contained (although temporary price spikes could occur again). Steadier oil prices would be a positive for global economic growth and equity markets.
  4. Tax reform for overseas earnings is unlikely. Absent broad corporate tax reform (which does not appear likely), we do not expect to see any sort of repatriation holiday or other reforms that would lower tax levels on non-U.S. earnings.
  5. A major equity market retrenchment looks unlikely. Since the 1970s, every major market correction has been preceded by a Fed rate hike, a double-digit rise in oil prices or an intense global crisis.3 We think the lack of these catalysts puts the odds of a major pullback quite low.

Cyclical Sectors Continue to Look Attractive

U.S. economic growth appears to be accelerating, which should be conducive to continued advances in equity prices. Valuations have been moving higher, and markets could be susceptible to a correction, but we believe any such setback should be modest and temporary, particularly considering that central bank policies are still accommodative. Additionally, we expect corporate earnings trends will improve along with the economy, which should act as a positive catalyst for the markets.

With this backdrop, we continue to support a pro-cyclical investment stance. In particular, the technology and industrials sectors appear to have strong earnings growth prospects and should benefit from an increase in capital expenditures, which should occur as the economy picks up steam.


1 Source: Morningstar Direct, as of 7/18/14 .
2 Source: RBC Capital Markets.
3 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.

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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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