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

Weekly Investment Commentary

Equity Losses Continue, but This Correction May Be Ending


October 20, 2014
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Key Points

  • Markets endured a sharp pullback and higher volatility, but technical factors suggest we may be nearing the end of the current correction.
  • Long-term, we believe fundamentals remain sound, the U.S. economy should continue to grow and equities should be able to grind higher.


U.S. equities endured a high degree of volatility last week, dropping sharply before recovering some of their losses. For the week, the S&P 500 Index lost 1.0%, marking the fourth consecutive down week for stocks.1 Global growth concerns and oversold conditions contributed to the downturn, as investors generally focused on large-scale macro issues and risks rather than on fundamentals and corporate earnings. Defensive sectors such as health care and consumer staples drove the market lower, while a bounce in cyclical stocks helped industrials and materials outperform.1 Small cap stocks rallied and outperformed large caps as they snapped a six-week losing streak.1

 

Market Technicals Turned Positive Amid High Volatility

Much of last week’s volatility occurred on Wednesday when equities opened by plummeting close to 2.5% amid huge volume.1 We estimate as much trading occurred in the opening half-hour as we see in a typical day. At the same time, the yield on the 10-year Treasury fell from 2.20% on Tuesday to 1.86% on Wednesday morning.1 Such moves represented panic selling in equities and panic buying in bonds as investors fled into “safe haven” assets.

Importantly, however, markets recovered some of their early-day losses before experiencing another pullback later Wednesday. Although the afternoon decline was greater than that morning’s, it was more orderly with less trading volume. This suggests we may have been seeing the beginning of the end of corrective action.

Thursday saw an additional test of the market lows, but investors began buying shares back, which was another good sign. More importantly, market factors showed at least some degree of risk appetite returning in the second half of the week. Cyclical sectors outperformed defensive sectors, energy stocks recovered, commodity prices rose and equities saw notable advances on Friday.1 We view all of these factors as further evidence that the correction may be in the process of ending.

 

We Believe This Equity Bull Market Should Persist

To put current market action into perspective, this is now the fourth correction we have seen so far this year. Equities fell 7% in January, 4% in April and 5% in August. If the bottom seen on Wednesday holds (1,820 for the S&P 500 Index) that would represent a 10% decline from the intraday high reached on September 19.1

Despite the most recent decline, however, we believe fundamentals have not changed significantly. The proximate cause for the current pullback appears to be heightened concerns about European growth and deflation, but these issues are not new. Likewise, concerns over Federal Reserve policy, geopolitics and corporate earnings have been present for months. In our view, the current correction has been more technical in nature. Markets were overdue for a 10% correction and investors seem to be responding to the same fears that have been around for some time.

We remain cautiously optimistic about the state of the U.S. economy. If anything, recent trends could help. Energy prices have fallen sharply over the past few weeks and months, which acts as a de-facto tax cut for consumers. And lower interest rates should help the housing market. As long as U.S. growth holds up, corporate earnings should be decent enough, allowing equity markets to grind higher.

In addition, equity markets tend to perform quite well in the aftermath of midterm elections (often following a difficult September/October period). In fact, since 1950, the S&P 500 Index experienced positive returns in every six-month period following the last 16 mid-term elections, with an average gain of 16%.2

At the end of the day, we still believe that equities appear attractive, especially relative to Treasuries. At present, the dividend yield of the S&P 500 Index is 2.1%, which is pretty close to the yield on the 10-year Treasury.1 This means that stocks are producing roughly the same current income as government bonds, but stocks also offer the prospects for growth and dividend increases, which bonds do not.

Looking ahead, we expect volatility to remain relatively high and markets could again test the bottoms seen last week. But evidence suggests it is more likely than not that this current correction is ending and that the long-term prospects for equities remain sound.

 

1 Source: Morningstar Direct, and Bloomberg as of 10/17/14
2 Source: BCA 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

Equities Pummeled by Global Growth Fears


October 13, 2014
 
 

Key Points

  • Equities fell for their third straight week, as investors are becoming more concerned about global growth and deflation.
  • Despite these concerns, we believe U.S. growth should remain resilient as the U.S. continues to diverge from other markets.
  • For those investors willing to ride out the volatility, we continue to suggest overweight positions in equities.


U.S. equity markets endured their third consecutive week of losses as volatility climbed.1 The S&P 500 Index lost 3.1%, its largest weekly decline since May 2012.1 The sell-off can be blamed on a number of factors, with concerns over global growth coming in first on that list. Ongoing angst over the end of the Federal Reserve’s quantitative easing program and trepidation in advance of third-quarter earnings reports can also take their share of the blame. Energy was the worst performing sector of the market, with oil prices falling more than 4% for the second straight week.1

 

U.S. Liquidity Is Fading, While Europe Needs More Support

Since the financial crisis, risk assets have benefited from the massive amount of liquidity that the Fed injected into the system. With that high liquidity phase now coming to an end in the United States, stronger economic and earnings growth must serve as the driving forces if the bull market in risk assets is to continue.

The story outside of the United States is far different. Disappointing European economic data and the recent significant weakness in the major European stock markets are additional reminders that the European Central Bank (ECB) is well behind the curve in its easing programs. Unless and until the ECB proves it is serious about supporting economic growth, European equities are likely to struggle.

 

Weekly Top Themes

  1. U.S. growth has remained resilient. Falling energy prices and lower interest rates have been supporting consumer confidence, and the labor market continues to show signs of strength. In contrast, the data from Europe has been weak, with German industrial production plummeting by its largest annual decline since January 2009.2 Should the eurozone fall into outright recession, we would become more concerned about U.S. growth.
  2. Recent data confirm that U.S. employment is improving. Last week, initial and continuous jobless claims both fell.3
  3. We expect more earnings disappointments this quarter than in the recent past. Weaker global growth and a stronger U.S. dollar could hurt earnings and revenues, especially for multinational companies.
  4. The federal budget deficit shrank for the fifth consecutive year. Initial Congressional Budget Office estimates for fiscal year 2014, which ended on September 30, show the deficit was only 2.8% of gross domestic product. Outlays rose by only 1%, revenues grew almost 9% and discretionary spending fell 3%.
  5. We expect to see wage inflation begin in the first half of next year. Although inflation remains broadly contained, the declining unemployment rate suggests to us that some wage acceleration is due.
 

Global Deflation Scare Should Not Affect the U.S.

Global financial markets are being buffeted by fears of recession and deflation that are centered primarily in the eurozone. The silver lining to the ongoing turmoil is that we expect European authorities to move off of the sidelines and finally take enough action to rekindle economic confidence. The Fed is also keenly aware of the problems in Europe and will proceed carefully as it shifts policy.

These growth and deflation fears have been with us in some form or another since the global financial crisis began, but they have intensified in recent months and have been growing beyond the eurozone. There are concerns that the stronger growth experienced in the United States will not continue and that the U.S. will begin importing deflation and economic stagnation. We believe such fears are premature as recent data and forward-looking indicators suggest U.S. growth is moving into a higher gear. Deflation fears have been compounded by the recent slide in oil prices, but we believe this shift has more to do with a meaningful increase in supply and less demand due to greater efficiencies. In the long term, lower oil prices should help U.S. growth.

We recognize the high probability of further short-term turbulence, but continue to favor a pro-growth investment stance. Specifically, we believe the U.S.-led economic recovery will persist, which should help produce further gains for equity markets.

 

1 Source: Morningstar Direct, as of 10/10/14
2 Source: Federal Statistical Office of Germany (Destatis)
3 Source: U.S. Department of Labor

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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