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Global equities sustain rally amid vaccination gains and growing pains

Equities Investment Council
The Nuveen Equities Investment Council is led by Saira Malik and comprises the firm’s senior portfolio managers averaging three decades of investing experience.
Saira Malik
CIO, Head of Global Equities
Looking up the walls of a curved building

Equity market overview and outlook for Q3 2021

Global equities were broadly positive in the second quarter, but the ride wasn’t entirely smooth. Economic growth rates largely depended on vaccination progress and governments’ ability to contain COVID-19 and its more contagious variants. Central banks were in the spotlight as inflation pressures mounted due to base effects and global supply chain shortages in the face of powerful pent-up demand. While these factors sparked volatility at times, most equity markets ended the period on steady and higher ground.

Key takeaways

Vaccination gains, supply chains and growing pains

The equity market exuberance of the first quarter carried into the second, although returns for major indexes were generally more moderate. Historic levels of fiscal and monetary stimulus persisted, providing ongoing support to individuals, businesses and financial markets. Globally, economic growth rates varied by country and region, in large part depending on the degree of progress made in vaccinating populations against COVID-19.

Figure 1: The U.S. is a leader in seeking to control COVID-19

U.S. vaccination efforts have been among the most effective, though lagging the U.K., Israel and China. It became clear during the quarter that President Biden’s original goal of a 70% inoculation rate by the Fourth of July would be missed. Overall, as shown in Figure 1, developed nations tended to be more successful than their emerging markets (EM) counterparts in gaining an upper hand against the virus. Japan was a notable outlier, with a disappointing 24% vaccination rate. In the EM sphere, both Brazil and India suffered from surging case counts and challenging vaccine delivery logistics.

Against this backdrop, the U.S. accelerated economic reopening during the quarter and led the global growth recovery. This, in turn, enabled U.S. equities to outperform their non-U.S. peers (Figure 2), just as they had done in the first quarter. The S&P 500 Index overcame some bouts of volatility and rallied in late June, notching a series of consecutive all-time highs.

Figure 2: U.S. equities outperformed non-U.S. markets

The Fed is not fed up with inflation (yet)

Hotter-than-forecasted Consumer Price Index (CPI) data and expectations of higher future inflation rates were a source of equity market volatility during the quarter, primarily due to concerns that the Federal Reserve may accelerate its timetable for tightening its ultra-dovish monetary policy. Several factors contributed to higher inflation:

Base effects. For April and May, year-over-year CPI increases hit their highest levels since 2008. These readings were distorted by comparisons to the exceptionally low (sub-1%) inflation rates that prevailed during those same months in 2020, when the economy was in the depths of the pandemic-induced recession.

Supply chain disruptions. With the economy reopening more swiftly than expected, unleashed pent-up demand overwhelmed available supply in certain sectors, fueling sharp price increases.

Commodity prices. While prices for many commodities either stabilized or declined following the first quarter’s broad-based rise, oil prices continued to climb as crude inventories shrank and demand surged. West Texas Intermediate oil jumped 23%, from $59 to $74 per barrel, reaching levels in June not seen since 2018.

Wage pressures. Despite record levels of open positions, net monthly payrolls underwhelmed in April and May, as large numbers of unemployed Americans remained on the sidelines. Many employers, unable to staff up as the economy boomed, sought to entice potential workers with higher pay. This contributed to fears that stronger wage growth would put upward pressure on the overall inflation rate.

The Federal Reserve maintained that higher inflation was being driven by transitory forces that would recede as the economy moved closer to normalization. The markets greeted this mantra with varying degrees of skepticism and hope. For most of the quarter, the Fed also stuck to its guns regarding its expected time frame for transitioning to tighter monetary policy.

That commitment, however, seemed more tenuous at its June meeting. Although the Fed pledged to remain accommodative, it upgraded its inflation forecasts (Figure 3), with Chair Jerome Powell acknowledging “the possibility that inflation could turn out to be higher and more persistent than we anticipate.” Moreover, the Fed’s closely watched dot plot showed most members expect the Fed to raise rates in 2023. A majority believe there will be at least two hikes that year, and a sizable minority suggest rate increases could begin as early as 2022. These views represented significant shifts forward in the anticipated timing of rate lift-off versus the Fed’s last set of forecasts in March.

Markets, interpreting the meeting in the most hawkish light, threw a mini-tantrum. But the volatility was short-lived, as the Fed quickly sought to clarify its intentions and reiterated that its timeline for tapering its quantitative easing asset purchases (early 2022) and raising rates (early 2023) remained intact.

Figure 3: The Fed raised GDP and core inflation forecasts in June

Second quarter trends and highlights

Earnings growth rebound was key

In the U.S., momentum from the economy’s reopening and blockbuster corporate earnings results (Figure 4) helped counter concerns that hotter inflation would cause the Fed to pivot from its ultra-accommodative policy stance. S&P 500 earnings grew 52% year-over-year during the quarter, more than twice the rate of growth initially estimated. On a sector basis, consumer discretionary, financials and materials recorded the largest earnings increases.

Figure 4: S&P 500 earnings growth blew past consensus estimates

Substance over style

After trailing value by a wide margin in the prior two quarters, growth outperformed in the latest period. But chasing the value vs. growth dynamic required a willingness to be whipsawed, as cyclical/ value and technology/growth shares constantly traded market leadership. Value still led growth year-to-date through June, but the margin has narrowed considerably.

This erratic showing demonstrates why betting on one style based on the magnitude or duration of past outperformance is not a sound strategy. Style performance drivers tend to be period-specific, hard to predict and unlikely to be repeated. For these reasons, we focus on selectivity, bottom-up research and a balanced approach to growth and cyclical allocations.

Chasing the value vs. growth dynamic required a willingness to be whipsawed, as the two styles constantly traded market leadership during the quarter.

Dollar bucks trend, but for how long?

The U.S. dollar has trended significantly lower against other currencies since the COVID-19 outbreak in early 2020. But following another leg downward in April and May, the dollar reversed course and strengthened 2.5% in June. This countertrend, while notable, has been driven by short-term technical factors rather than a change in economic fundamentals. We consider it a bear market rally and believe the longer-term trend of dollar weakness remains intact, which should support non-U.S. equities.

U.S. indexes: Tech and large caps had the edge
Growth dominated value, except in small caps
Real estate led all sectors, while utilities lost ground

Outlook and best investment ideas

Annualized U.S. GDP growth for the second quarter is projected at around 8%, representing peak expansion after the first quarter’s 6.4% rate. While an 8% headline number would be impressive, the economy has already begun to show some signs of decelerating as the pace of vaccinations plateaus and the effects of stimulus and pent-up demand fade.

Meanwhile, other parts of the world are still ramping up vaccine distribution and economic reopenings, providing greater potential upside in growth. Figure 6 shows projected eurozone and emerging markets GDP growth for 2022 exceeding that of the U.S. This shift in economic momentum reflects the sequential, rather than synchronized, nature of the global recovery. This is a key to our near- to medium-term outlook and equity market preferences.

Figure 6: European and EM economies are poised to outgrow the U.S.

Non-U.S. equities

Earnings growth has peaked, but opportunities remain

In the U.S., consensus estimates call for second quarter earnings growth of 60% to 65%. This would be the largest year-over-year increase since the quarters immediately following the global financial crisis and likely represents peak earnings growth for this cycle. That doesn’t mean investors should be preparing for an imminent end to the current economic recovery. The effect of the rising tide of the economy lifting all boats is likely to wane, and the theme of peak growth has spurred some recent volatility in equity markets. But we expect economic progress to continue, especially considering the eventual impacts of filling 9 million U.S. job openings and the sequential global recovery that is still in its early stages.

Figure 7: Non-U.S. indexes offer greater cyclical exposure
A potential strong economic rebound and a weaker U.S. dollar support an increased allocation to non-U.S. equities.

U.S. equities

Global opportunities

Risks to our outlook

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Index Performance: FactSet; European Corporate Earnings: I/B/E/S; U.S. Corporate Earnings: Standard & Poor’s; Employment: RBC Global Asset Management; Russell Indexes: FactSet, Russell Investments; Valuation gap: Alliance Bernstein.

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.

A word on risk
All investments carry a certain degree of risk, including possible loss of principal, 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-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.

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