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

Weekly Investment Commentary

Falling Oil Prices Cause Jitters,
but the Economy Stays on Track


December 15, 2014
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Key Points

  • Falling oil prices are causing near-term uncertainty but should benefit economic growth over time.
  • The Fed may signal this week that it is getting ready to begin increasing interest rates.
  • Economic growth continues to improve, which should act as a further tailwind for equity prices.


The dominant financial story last week was the concern over the continued slide in oil prices, which have dropped close to 40% so far this year.1 Worries about the growing power of the Greek opposition party Syriza, and the potential effect on European policy should it assume control over the government, also contributed to investor unease. For the week, the S&P 500 Index fell 3.5%, snapping a seven-week winning streak and suffering its largest one-week pullback since May 2012.1 Energy stocks led the decline, while some defensive sectors such as utilities fared better.1 High yield bonds also sold off and investors poured money into Treasuries as risk aversion spread.1

 

The Benefits of Lower Energy Prices Outweigh the Risks

Falling oil prices do present risks. Lower prices hurt energy producing companies and regions and, as we saw last week, any sudden or sharp moves in financial markets can spill over onto other asset classes. Overall, however, we believe lower oil prices will help economic growth. Consumers should benefit most, as money spent on gasoline and heating costs can be redirected to other areas.

 

Weekly Top Themes

  1. This week’s Federal Reserve meeting may mark an important shift in tone. Specifically, we expect the Fed could drop the phrase “considerable time” when discussing how long it intends to keep the fed funds rate near zero. This would mark the beginning of a multi-month process of preparing the markets for the first rate hike, which we believe could occur in mid-2015.
  2. Strong retail sales figures act as additional evidence of improving economic growth. Sales climbed 0.7% in November, the strongest gain we have seen in eight months.2 These results should help assuage any concerns about a weak holiday shopping season.
  3. Small business confidence is rising, which should help employment gains. November’s Small Business Optimism Index rose to its highest level since 2007.3 Since small businesses typically drive jobs gains during economic expansions, this bodes well for the future of the labor market.
  4. Inflation remains low, and there is little sign that expectations will rise. Despite a months-long trend of economic data that have been exceeding expectations, inflation levels remain subdued. Lower oil prices and a stronger U.S. dollar are helping to keep downward pressure on inflation.
  5. The history of the presidential cycle suggests equities could benefit in 2015. Next year will mark the third year of the presidential cycle. Since 1950, the S&P 500 Index has averaged a 16.5% annual return during those third years.4 In particular, January has been a strong month, showing a 4.3% average return with only one decline during that period.4
 

We Suggest a Continued Focus on Equities,
Avoiding Energy and Resource Investments

Oil prices are likely to remain volatile and downward pressure will persist unless production levels are cut or demand rises. Additionally, it will take some time to fully feel the beneficial effects of lower prices. Before that happens, there is a risk volatility will contribute to uncertainty about the economy and financial markets. However, the lesson from the 1986 oil market crash (when prices dropped 65%),1 is that the negative effects were short-lived and massive stimulus that followed more than offset any problems.

We would encourage investors to focus on the long-term benefits of the current disruption. We have not seen widespread financial or banking system problems due to lower oil prices and we expect policymakers to be sensitive to any economic issues that ensue. The six- to twelve-month economic outlook has improved as a result of the slide in commodities. We think energy and resource investments look challenging right now, but the backdrop should be conducive to improving equity markets. Investors should be on the watch for signs of stability in oil prices, which could signal a renewed upturn in equity markets.

 

1 Source: Morningstar Direct and Bloomberg, as of 12/12/14
2 Source: U.S. Department of Commerce
3 Source: National Federation of Independent Business
4 Source: Strategas Research

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

An Improving Economy Justifies a
Pro-Growth Investment Stance


December 8, 2014
 
 

Key Points

  • Global growth should accelerate modestly over the coming year, providing a tailwind for equities.
  • We believe the Federal Reserve may need to provide a clearer signal about when it will begin rate increases.
  • Downward pressure on oil and energy prices should persist, suggesting that commodities may continue to struggle.


U.S. equities advanced again last week with the S&P 500 Index climbing 0.4%, extending its winning streak to seven weeks.1 Investors responded well to improving economic data and focused on the positive aspects of declining oil prices. In China, equities moved sharply higher and notched their best weekly performance in seven years1 as investors speculated that Chinese officials were on the verge on enacting additional policy support.

 

Global Growth Should Accelerate in 2015

At the beginning of 2014, most observers (us included) expected that equity markets would have a good year but rising rates would challenge areas of the bond market. As we approach the end of the year, it appears we were correct about equities performing well, but the bond markets have also experienced good results (through the end of last week, the Barclay’s U.S. Aggregate Index was up 5.3% for the year).1 The global economy has underperformed expectations so far this year, which has kept bond yields low.

We expect that 2014 global gross domestic product will have grown by around 2.5% or 2.6%. Next year, we believe less fiscal tightening, increased monetary stimulus and improving confidence should push global growth over 3%.

 

Weekly Top Themes

  1. Significant improvements in the labor market will pressure the Federal Reserve to begin increasing rates. November’s payroll report showed that 321,000 new jobs were created last month, significantly ahead of expectations.2 Given the pace of growth, it is increasingly difficult to justify the current low level of the fed funds rate. We’re keeping a close eye on December’s Fed policy meeting to see if the central bank begins signaling the timing of rate increases.
  2. We believe Treasury yields will begin rising over the coming months. The significant fall in Treasury yields was perhaps the biggest market surprise in 2014, but we believe the beginning of Fed rate increases, improving global growth and a bottoming of inflation should act to push yields higher.
  3. Increasing production levels should keep downward pressure on oil prices. Even if OPEC does decide to begin limiting supplies, increased production from the United States is likely to continue. The International Energy Agency estimates that U.S. production could exceed that of Saudi Arabia by the end of next year.3
 

Equities Look Compelling, but Commodities May Struggle

It has been a wild ride for investors in 2014, with bond yields declining and equity markets reaching record highs. U.S. equity markets appear on track for another year of double-digit gains despite long-held and widespread concerns that stocks were overdue for a significant correction. Non-U.S. equities have lagged, largely as a result of weaker economic growth and deflation fears.

Despite uneven global growth and persistent deflation concerns, we do not expect any major markets to enter depression territory despite that fact that government bond yields in several European countries and in Japan are low enough that they are signaling such an environment. In fact, as we stated earlier, we believe global growth should accelerate and should improve enough to allow equity markets to grind higher.

Healthy earnings growth has been the primary driver of equity returns this year, and we expect that trend will continue into 2015, with cyclical areas outperforming defensive sectors (for both the U.S. and global markets). The main threats to this outlook would be a recession, a deflationary environment or a drop in confidence. All seem unlikely to us, suggesting that the path of least resistance for stocks would be for prices to move higher. We do not expect equity gains to match the pace they experienced over the past several years, but equities still look attractive relative to other asset classes.

We have a less sanguine view toward energy and commodity prices. The recent pullback has been extremely sharp and quick, which suggests that some areas of the market may be oversold and due for a near-term bounce. Over the longer-term, however, we think the “cheapness” of energy prices is justified due to poor fundamentals, and we expect supply and demand dynamics to keep downward pressure on energy and other commodities.

 

1 Source: Morningstar Direct and Bloomberg, as of 12/5/14
2 Source: U.S. Bureau of Labor Statistics
3 Source: International Energy Agency

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Barclays U.S. Aggregate Index covers the U.S. investment grade fixed rate bond market.



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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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