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

Weekly Investment Commentary

Drags on the Economy and Earnings Should Slowly Fade


April 20, 2015
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Key Points

  • Corporate earnings have been held back by falling oil prices and the stronger U.S. dollar. These headwinds should diminish by the second half of 2015.
  • Despite a preponderance of negatives, we believe the global economy is slowly improving, which should help equities post additional gains.

Investors focused on the negatives last week, including some disappointing U.S. economic data and growing concerns over what will happen with Greece’s debt problems. U.S. equities fell, with most of the damage coming on Friday amid a global risk-off trade.1 The S&P 500 Index declined 1.0%, with the industrials sector leading the way downward.1 In contrast, energy performed the best, helped by a rally in oil prices.1 Outside of the United States, Chinese stocks continued to soar,1 as weak economic data sparked expectations for additional policy support. Over the weekend, these expectations came to fruition when the People’s Bank of China announced a cut in bank reserve requirements, a move designed to boost lending.

 

Weekly Top Themes

  1. Earnings expectations look weak, but we expect a rebound later this year. Standard & Poor’s is currently forecasting 2015 earnings for the S&P 500 to increase by a mere 0.2%.2 Most of this weakness is concentrated in the energy sector, and excluding energy, the growth rate would be 7.5%.2 Oil prices and the U.S. dollar both appear to be stabilizing, which we believe should help earnings outperform expectations in the second half of 2015.
  2. The beneficial effects of lower oil prices have yet to be realized. In our opinion, the drop in oil prices happened so quickly that the results have yet to work their way through the economy. Even if prices don’t drop further and stay close to their relatively low levels, we think we could still see downward pressure on gasoline prices. Additionally, we expect to see consumer spending rise over the coming months.
  3. We continue to have a bullish long-term view toward the dollar. Given the enormous increase since last summer, however, a period of consolidation or correction could last for weeks, or possibly even months.
  4. Core inflation appears to be starting to pick up modestly. The core Consumer Price Index ticked up from 1.7% to 1.8% in March,3 which is consistent with our view that inflation is moving from around 1% to closer to 2%. Higher inflation should put pressure on the Federal Reserve to change its current stance. We continue to believe the Fed will begin increasing rates later this year, with September being the most likely liftoff point.
  5. Despite the recent strength in the energy sector, we have a negative view toward energy stocks. The recent bounce can largely be attributed to the stabilization in oil prices. At current prices for energy stocks, investors appear to be forecasting a sustainable rise in the price of oil. We do not expect oil prices to experience a significant advance, which may mean that the energy sector could be at risk. Even if oil prices do rise, we believe the relative upside in energy is limited given higher oil prices are already discounted.
 

Equities Are Treading Water, but Look Resilient

Equities have struggled in recent weeks amid a slowdown in the U.S. economy, drama over Greece’s debt negotiations, lingering concerns about pockets of deflation and increased geopolitical tensions. Under the surface, however, it looks to us like the global economy is gradually recovering. In the United States, the twin drags of lower oil prices and a stronger dollar appear to be fading and the outlook is brightening. Europe, which has long been a source of risk, looks to be stabilizing, with increased monetary policy support helping to combat deflation. A potential messy exit of Greece from the eurozone is a key source of risk and is holding back investor confidence, but our view is that we should see at least a temporary deal to prevent that from happening.

Despite an abundance of negative factors, U.S. equities have held their ground so far this year. The main headwind for stock prices has been the deteriorating earnings environment, and while we expect a period of soft earnings to persist, the longer term outlook does look brighter. Equity valuations may look a bit stretched, but we do believe that they look attractive compared to government bond markets. Assuming global economic activity continues to improve, we believe there should be further room for equities to advance.

 

1 Source: Morningstar Direct, as of 4/17/15
2 Source: Standard & Poor’s
3 Source: Bureau of Labor Statistics



 

Last Week's Commentary

Global Economic Risks Remain but Appear to Be Diminishing


April 13, 2015
 

Key Points

  • Lower oil prices and the rising dollar remain sources of concern and have been hurting corporate earnings, but the effects of both should fade by the second half of 2015.
  • The global economy appears healthier than it has in years, suggesting to us that investors should overweight equities in their portfolios.

Investors reacted to a range of data and news last week that included a further digesting of the relatively weak March jobs data, ongoing merger and acquisition news, signs of weakening corporate earnings and further evidence of upward pressure on wages. Amid all of the crosscurrents, U.S. equities finished higher, with the S&P 500 Index gaining 1.7%.1 Most international markets advanced as well, while Treasury yields and the U.S. dollar rose.1 Industrials, health care and energy stocks led the way while telecommunications, utilities and financials lagged.1

 

Weekly Top Themes

  1. Corporate earnings may decline in 2015. The combination of the 50% fall in the price of oil and the 20% rise in the value of the U.S. dollar since last June is depressing corporate earnings.1 We estimate that were it not for these factors, earnings per share growth for the S&P 500 would be somewhere around 8% to 10% this year.
  2. The oil and dollar dynamic may start to fade a bit. We believe oil prices may have reached or be near the end of the worst of their bearish phase, but we also think it will take some time for prices to advance given the current supply/demand environment. The bull market in the dollar is likely to continue, but at a much less frenetic pace.
  3. Wages are starting to increase. The March payroll data showed that year-over- year average hourly earnings were up 2.1% and unemployment remained at 5.5%.2 These figures provide evidence the labor market is tightening as companies are stepping up efforts to retain workers.
  4. A Federal Reserve rate hike cycle is likely to kick off later this year, but we don’t expect dramatic increases. The Fed is attuned to financial markets, and investors are closely watching the Fed as they wonder when the liftoff will begin and how high the fed funds rate will go. Our view is that September 2015 seems the most likely timeframe, and we believe an increase in the fed funds rate to between 1.5% and 2.0% would be neutral given prevailing economic conditions.
  5. Equity market technicals appear supportive of further price gains. Although the market as a whole has moved sideways for much of this year, technical conditions are healthy. According to data from Strategas Research, 70% of companies within the S&P 500 are currently in an uptrend.3 That compares to only 43% of companies at the market peak of October 2007 and only 27% at the March 2000 high.3
 

Tailwinds for Equity Markets Should Pick Up

Although several major equity markets are at or near their all-time highs, investors remain nervous and uneasy about the state of the global economy (as evidenced by extremely low government bond yields). In recent weeks, investors have been focusing on relatively weak U.S. economic data, geopolitical turmoil, Greece’s debt woes and the strength of the U.S. dollar. The last item on this list has been a particular source of worry, with some fearing the dollar’s strength could jeopardize the U.S. recovery and trigger debt defaults in emerging economies. In our view, neither is likely. The rising value of the dollar is consistent with an improving domestic economy, and it also helps promote global growth.

We believe U.S. growth will bounce back in the coming quarters given the strength in the labor market and a solid backdrop for consumer spending. Outside the United States, growth has been patchy but is showing signs of improvement. Supportive monetary policy remains a powerful force for global growth, and in our view, structural headwinds and risks to growth have been diminishing. The global economy remains vulnerable, but we believe it is healthier than at any time since the Great Recession began.

From an investment perspective, we would point to several considerations in light of our constructive outlook. The first is that bond market volatility is likely to rise as we approach the start of the Fed rate increase cycle. Equity market volatility should move higher as well, but we think equities are more attractively valued than government bonds. Given this environment, we continue to advocate overweight positions in equities, underweight positions in Treasuries and commodities and a neutral stance toward cash.

 

1 Source: Morningstar Direct and Bloomberg, as of 4/10/14
2 Source: Bureau of Labor Statistics
3 Source: Strategas Research Partners



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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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