Robert C. Doll, CFA
Senior Portfolio Manager,
Chief Equity Strategist
Nuveen Asset Management, LLC
Weekly Investment Commentary
A Mid-Year Assessment of
Our Ten Predictions
June 27, 2016
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So far, 2016 has been a year that has frustrated both the bulls and the bears.
Last week’s Brexit vote is likely to cause additional near-term volatility, but shouldn’t derail the U.S. equity bull market.
Equity gains are likely to be modest compared to the post-recession pace, but we expect prices to move unevenly higher.
In January, we described 2016 as a year that would likely frustrate both the bulls and the bears. At the halfway point, that has certainly come to pass. We have already seen a double-digit decline in U.S. equities followed by a double-digit recovery.1 And stock prices remain uneven as investors focus on uncertain Federal Reserve policy, mixed economic and earnings data and, most recently, the political and financial turmoil following the Brexit vote.1 We forecasted equity prices would be volatile in both directions but would end the year close to where they began. With six months to go, the predictions we made at the beginning of the year are mostly on track:
|✔||Heading in the Right Direction|
|❓||Too Early to Call|
|❌||Heading in the Wrong Direction|
||U.S. real GDP remains below 3% and nominal GDP below 5% for an unprecedented tenth year in a row.
The U.S. economy grew only 0.8% in the first quarter.2 We expect the economy to rebound modestly. U.S. economic fundamentals are not likely to be negatively affected by the Brexit vote in the near term.
||U.S. Treasury rates rise for a second year, but high yield spreads fall.
Treasury yields fell sharply at the end of last week and are notably lower than the start of 2016.1 High yield spreads have moved unevenly, but have fallen from 660 basis points to 587 basis points.3
||S&P 500 earnings make limited headway as consumer spending advances are partially offset by oil, the dollar and wage rates.
Corporate earnings have been weak over the past year, but we expect a modest recovery over the coming quarters.
||For the first time in almost 40 years, U.S. equities experience a single-digit percentage change for the second year in a row.
Prices have been quite volatile in 2016, but equities are trading close to where they began the year.
||Stocks outperform bonds for the fifth consecutive year.
Stocks are currently trailing bonds, but we still expect to get this prediction correct by year-end.
||Non-U.S. equities outperform domestic equities, while non-U.S. fixed income outperforms domestic fixed income.
U.S. stocks have outperformed most other markets. In contrast, non-U.S. fixed income has outperformed U.S. fixed income. (The Barclays Global Aggregate Bond ex U.S. Index is up 11.4%, compared to 4.7% for the Barclays U.S. Aggregate Bond Index).1
||Information technology, financials and telecommunication services outperform energy, materials and utilities.
Unfortunately, we are on the wrong side of this prediction. A basket of our favored sectors is up 3.9% for the year while our least-favored are up 12.7%1
||Geopolitics, terrorism and cyberattacks continue to haunt investors but have little market impact.
The Brexit vote sparked near-term uncertainty, but we expect the global and U.S. economies should survive the fallout. And sadly, as the massacre in Orlando shows, terrorism has become increasingly common. Overall markets effects, however, have been limited.
||The federal budget deficit rises in dollars and as a percentage of GDP for the first time in seven years.
Federal spending levels are set to rise in 2016.4
||Republicans retain the House and the Senate and capture the White House.
Current polling suggests Hillary Clinton is favored over Donald Trump and the Republicans appear in danger of losing the Senate. There are still more than four months to go, however, which is an eternity in politics.
Equities are no longer as cheap as they once were. But we think valuations are reasonable, especially compared to bonds and cash. We expect the global economy to improve unevenly, which should help corporate earnings recover. If this occurs, equities should be able to move unevenly higher. The pace of gains, however, is likely to be slower than what investors experienced during the first six years of this bull market. Within the equity market, we prefer mid-cycle cyclicals, companies that can generate positive free cash flow and those with higher levels of domestic earnings.
1Source: Morningstar Direct, Bloomberg and FactSet as of 6/24/16
2Source: Commerce Department
3Source: Barclays. Spreads reflect the option-adjusted spread of the Barclays High Yield 2% Issuer Capped Index relative to Treasuries
4Source: Congressional Budget Office
Last Week's Commentary
Equities May Struggle, but Should
Outperform Other Asset Classes
June 20, 2016
Corporate earnings remain the key for equity prices. If earnings and profits improve over the coming months, equities should break out to the upside.
The Brexit vote and the U.S. elections are causing an unusual amount of political uncertainty, but shouldn’t derail the markets.
Last week started on a horrific note with the massacre in Orlando. That event and growing anxiety over the possible U.K. exit from the European Union (the Brexit) dragged down investor sentiment. The S&P 500 Index fell 1.1% last week.1 Financials came under pressure, while the more defensive telecom and utilities sectors bucked the broader trend and gained ground. Non-U.S. stocks fared even worse, with European markets declining around 2% and Japanese stocks dropping over 3%.1
Weekly Top Themes
A Federal Reserve rate hike in July is unlikely. The decision to keep rates on hold came as no surprise, as the Fed pointed to recent labor market weakness and escalating global risks. If the June jobs report shows a strong rebound and the Brexit risk is avoided, the odds of a rate hike next month would rise.
The solid retail sales report from May should allay fears of a weakening economy. Sales rose 0.5% last month,2 which should provide some comfort to those who feared May’s weak jobs report was the start of a broader economic downturn. We believe that real gross domestic product may grow by as much as 3% in the second quarter.
The manufacturing sector, however, continues to struggle. The latest data from May shows industrial production fell 0.4%.3
Inflation continues to rise slowly. The headline consumer price index increased by a modest 1.0% annual rate in May.4 However, core inflation ticked up to 2.2%, the seventh consecutive month in which core inflation rose by 2% or more.4 We expect firmer commodities prices and the fading strength of the dollar should push inflation modestly higher over the coming months.
Still-low rates are a positive for equities, but earnings remain the key variable. Investors were cheered last week by indications that the Fed is in no hurry to raise interest rates. Looking ahead, we think the key factor that will drive equity prices is whether corporate earnings and profits can improve over the second half of 2016 and into 2017.
Global deflationary forces have faded, but have not vanished. Early in the year, weak commodity prices and worries over Chinese growth were triggering widespread deflation concerns. Deflation risks have receded, but remain. A steepening in global yield curves would be a key signal that deflation risks are finally in the rearview mirror.
Prospects for equities are mixed, but appear stronger than other asset classes. After appreciating significantly since 2009, equities are not as cheap as they used to be, but we believe they are also not in bubble territory. We think gains will be tough to come by in a slow-growth world, but we still think equities will outperform bonds and cash over the next six to twelve months. As such, we think investors should retain a pro-growth investment bias.
U.K. and U.S. Politics Are Causing Near-Term Uncertainty
The most pressing political risk is the Brexit threat. We think the odds favor the June 23 referendum not passing, keeping the U.K. in the European Union. But there is a real chance that the U.K. will choose to leave. The uncertainty has undermined economic confidence and has been a headwind for global stock markets. Should the Brexit happen, we think it would be a serious misstep that could not be easily remedied. We believe it would cause the U.K. economy to shrink and could spark housing and credit crises. A Brexit could also morph into a more widespread global financial problem as it drags down global trade levels.
The next political issue on the horizon is the uncertainty surrounding the U.S. elections. Whether or not investors like Hillary Clinton, her economic policies are clear and transparent, and come with a measure of certainty. The same cannot be said about Donald Trump, since his views are inconsistent and lacking specificity (at least as of now, and he does have five months to amplify and clarify his proposals). His most clearly articulated views indicate he may trigger trade wars, which would likely be negatives for the U.S. and global economies. From those perspectives, at least, we think equity markets would currently favor a Clinton victory.
1Morningstar Direct, and Bloomberg as of 6/17/16
2Source: Commerce Department
3Source: Federal Reserve
4Source: Labor Department
A Matter of Style: From Momentum to Free Cash Flow?
Markets may be undergoing a leadership change. And that could have implications for investors.
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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.