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

Weekly Investment Commentary

Further Equity Gains Await Earnings Recovery


March 30, 2015
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Key Points

  • The initial positive sentiment that occurred in the aftermath of the recent Fed meeting has faded a bit.
  • Earnings downgrades have been putting pressure on equity prices, but we anticipate that corporate earnings will improve in the second half of the year.
  • Economic growth should reaccelerate and the Fed is still likely to raise rates later this year.

Downward pressure on U.S. equities returned last week, with the S&P 500 Index falling 2.2%.1 This marked the second-largest weekly downturn of the year and the fourth negative week in the last five.1 Some of the decline can be attributed to fading positive sentiment that came in the wake of the recent Federal Reserve meeting. Ongoing negative earnings forecasts have taken their toll as well. All market sectors were in negative territory last week, with financials, technology and industrials losing the most ground and consumer staples and energy holding up the best.1

 

Weekly Top Themes

  1. Fourth quarter growth was a bit weaker than expected, but the consumer sector showed strength. Despite expectations that it would be revised upward, the gross domestic product growth report remained unchanged at 2.2%.2 One bright spot was that real spending hit its strongest level since 2006, suggesting that consumers have benefited from the drop in energy prices.2
  2. Corporate earnings estimates continue to weaken. Falling oil prices and the rising dollar have prompted analysts to cut expectations. Earnings for U.S. companies are now expected to grow 2% in 2015, down from 8% at the beginning of January.3 At the same time, sales are expected to contract by 1.0%, compared to growing by 2.5%.3 Downgrades have been concentrated in the energy sector, but the fallout from the strong dollar has also been hurting multinationals.3
  3. Concerns over an economic slowdown should be temporary. Given the recent spate of relatively weak economic data, we expect fears of a slump will persist over the next few months. Longer term, however, we believe stronger employment growth and improving consumer spending levels will cause some degree of economic optimism to return. We still expect the Fed will begin rate increases this year, which should reduce concerns over deflation. This shift should also cause bond yields to rise.
  4. The trend of global growth decoupling is persisting. Notwithstanding some recent data, the U.S. economy is still accelerating while China is showing signs of a deceleration. Within Europe, we are also starting to see evidence of different growth rates, with Germany appearing to improve as France, Italy and Greece struggle.
  5. Negotiations between Greece and the European Union remain stalled. Although we have not seen much progress in talks lately, we still expect a relatively benign outcome and do not anticipate that Greece will exit the European Union. Nevertheless, the possibility of some sort of significant financial disruption cannot be ignored.
 

Improving Growth Should Eventually Help Risk Assets

Equities have been struggling to find direction, with sagging profits weighing prices down and still-ample liquidity providing a tailwind. In the immediate aftermath of the recent Fed meeting, investors interpreted its statement as a sign that interest rate hikes may be delayed, but the Fed really hasn’t changed stances. It has indicated all along that any rate moves would be data dependent and has done little more than acknowledge that recent data has been somewhat disappointing. In our view, at least some of the recent softness is due to harsh winter weather and the West Coast port strikes, both of which are temporary factors. Looking ahead, we think the employment picture remains positive and we expect the broader data to rebound.

Despite the recent deterioration in earnings trends, U.S. equities have still held up reasonably well. We expect earnings data to remain volatile due to the twin factors of lower energy prices and a stronger dollar. However, earnings should improve in the second half of 2015 as the economic recovery regains traction. Stock prices are likely to remain volatile as well as investors digest earnings data and await more signals from the Fed. When the Fed does raise rates, it should do so slowly and carefully and it should serve as an acknowledgement that the economy has strengthened. Outside of the U.S., policy is still in an easing trend, which should help the global economy. Together, all of these factors should mean that we see solid returns for equities, particularly compared to bonds and cash. But until the earnings picture improves, gains will be tougher to come by.

 

1 Source: Morningstar Direct, as of 3/27/15
2 Source: Bureau of Labor Statistics
3 Source: MRB Partners



 

Last Week's Commentary

A Relatively Dovish Fed Statement Helps Equities
Recover Ground


March 23, 2015
 

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



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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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