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Kamp's Comments - Whither U.S. Stocks?

by Leo Kamp, Managing Director and Chief Investment Economist, TIAA-CREF

Over the past year, U.S. equity markets have been white hot, generally posting significant double-digit returns. And recently, we have seen the Dow Jones Industrial Average (the Dow) stock index climb to record levels, well above the 13,000 mark. However, it will still probably take some time before U.S. stock markets, in real (inflation-adjusted) terms, regain the highs reached in 2000.

Most of the outsized returns seen around the world over the past couple of years have come from a familiar source - people looking to enhance their investment returns by increasingly placing their investment funds in inherently more risky places.

This "stretching for return" has manifested itself in a number of investment arenas. High-yield (a.k.a. "junk") debt yields have fallen to near-record lows. Emerging market sovereign and corporate debt yields are also near historic lows, despite a steady stream of new issues coming to market. Both of these fixed-income categories, traditionally viewed as more risky, have benefited from investors' apparent willingness to look at better yields regardless of the higher risk that comes with them. So, investors' money keeps piling in, forcing the prices on these bonds to rise (resulting, of course, in the extremely low bond yields prevailing today).

However, this scratching around for better returns has not been confined just to bonds but has also percolated through to domestic and international equity markets. Emerging equity market stock prices have risen very sharply over the last few years. For instance, China's Shanghai market has increased more than 100% in the last year. India's stock market has also done spectacularly well over a similar time period. Other emerging equity markets have also posted impressive gains, though generally not as large as those of China and India. Certain equity markets, such as those in Europe, have seen good gains, too, especially in dollar terms due the sharp appreciation of European currencies versus the U.S. dollar.

Recently, U.S stock markets have also started to do quite well as investors have increasingly focused their funds there in order to participate in the upward price thrust and, again, to enhance their portfolio returns. The sustained price rise seen in these markets recently has, however, been late in coming, compared to the asset markets mentioned earlier. It has only been during the last year that U.S. markets have really taken off.

For the two to three years prior, outsized market returns were primarily seen in the investment arenas of high-yield debt, emerging market stocks and bonds, and certain developed-country equity markets. Now that high-yield bonds, emerging market fixed-income securities, and selected developed country stock markets seem unlikely to continue delivering stellar returns, investors have refocused some of their funds on the lagging U.S. markets, in the hope of perpetuating the strong performance investors have grown accustomed to.  Hence, it is not too surprising that the uplift in equity markets around the globe now includes those in the U.S. markets.

So, where does that leave us today? Will the now-record Dow continue to rise sharply? It's hard to tell how much longer the Dow will continue to surge upward. However, one thing seems likely: slower economic growth, less inflation, and less productivity growth this year mean that corporate earnings momentum should slow significantly in the United States ? something we're already seeing in the first quarter's earning reports.

Although first-quarter earnings growth still exceeds the long-term average, slower earnings growth should weigh heavily on stock values, which intrinsically depend on the growth of future earnings and dividends. So if earnings growth continues to tail off, it's hard to see how stock prices in the U.S. can continue to soar upward without some other positive force. 

One potential source of positive news might be the prospect of short-term interest rates moving lower. But, looking at Wednesday's (May 9) Federal Open Market Committee meeting, the Fed appears unlikely to cut interest rates this year. The Fed seems quite comfortable leaving short-term interest rates where they are today. So, the markets probably can't look to the Fed as a source of perpetuating the stellar U.S. equity returns of late.

Some might look to business investment or consumer spending as avenues for propelling the pace of the economy and corporate earnings higher. However, the prospect of a consumer rebound seems limited by the ongoing downturn in housing. And business fixed investment currently looks like it's on a slower track compared to last year.

Nonetheless, it's still hard to tell when the Dow's sharp rise will end or diminish. It is quite possible that the Dow could keep rising for some time to come. Only time will tell.

Leo also is available to comment on economic data. If you wish to speak with him or to be removed from future distributions, please notify Chad Peterson at 1 212 916-4808 / cpeterson@tiaa-cref.org.

Kamp's Comments are prepared by TIAA-CREF Asset Management and represents the views of TIAA-CREF's Investment Strategy and Client Solutions Group. These views may change in response to changing economic and market conditions . Past performance is not indicative of future results. The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons.

TIAA-CREF Asset Management is a division of Teachers Advisors, Inc., a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). TIAA-CREF® personnel in its investment management area provide investment advice and portfolio management services through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®). TIAA, TIAA-CREF, Teachers Insurance and Annuity Association, TIAA-CREF Asset Management and FINANCIAL SERVICES FOR THE GREATER GOOD are registered trademarks of Teachers Insurance and Annuity Association.

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Contact:
Chad Peterson
cpeterson@tiaa-cref.org
Phone: 212-916-4808
Mobile : 917-715-9083

Abby Aylman Cohen
aacohen@tiaa-cref.org
Phone: 212-916-4381
Mobile: 917-596-4758