William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets
August 23, 2013
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U.S. equity markets struggled to gain traction during much of the past week. For the week to date through August 22, the S&P 500 Index was essentially unchanged (+0.08%) but volatile day-to-day, hampered again by the inevitability of Federal Reserve tapering and the accompanying rise in interest rates. Foreign developed (-1.63%) and emerging-market (-3.72%) stocks fared worse, based on MSCI indexes.
Fixed-income returns were negative across most sectors amid quiet late-August trading. Reflecting the Fed’s latest “taper talk,” U.S. Treasury yields continued their upward climb. The 10-year Treasury yield closed at a two-year high of 2.90% on August 22 before edging back down toward 2.80% the following day in the wake of a weaker-than-expected July reading for new home sales. Fund flows continued to favor high-yield floating-rate loans, which offer protection against rising interest rates, while flows into fixed-rate bond categories remained light or negative.
U.S. housing trends remain in place, with a note of caution
There was little new economic news during the week, but three data releases are worth noting:
European manufacturing and consumer confidence show improvement
Europe continued to signal a nascent recovery, evidenced by a number of favorable data points:
We expect improving equity market performance in Europe to continue as economic activity picks up.
China’s manufacturing also improves
Chinese manufacturing data was also better, with the August flash PMI edging into expansionary territory (50.1). Although this had little or no effect on the Shanghai Stock Exchange “A” Share market, which has moved sideways, the “Chinext” index (Chinese technology stocks) surged to a new all-time high, supporting the notion that there are strong pockets of growth in China.
Japanese data suggest a bumpy road ahead for “Abenomics”
Japanese Prime Minister Shinzo Abe’s program to reinflate the economy continued to fall short of hopes.
While Japanese equities rallied late in the week, in part due to an optimistic “Tankan” reading (a survey of local Japanese manufacturers), we remain cautious about the prospects for Japanese equities and see further downside potential.
We continue to expect the U.S. economy to improve, but the pace of recovery is uncertain. Our forecast calls for GDP growth to pick up modestly, approaching 3.5% by the end of 2013, and to accelerate further as we move into next year. However, downside risks remain in the form of rising interest rates and a potentially negative market reaction to a premature or too aggressive tapering of the Fed’s bond purchases.
In U.S. equity markets, the August market correction has been driven by tapering fear and higher interest rates. It appears to us that tapering is now almost fully discounted, while Treasury yields may have reached a ceiling. Meanwhile, extreme bullishness has been tamped down.
In fixed-income markets, once Treasury yields settle in a stable range, “spread products” (higher-yielding, non-Treasury securities) may stage a rally, offering some respite to battered fixed-income investors. An increase in mortgage rates above their current level of 4.5% on conventional 30-year loans, as well as continued fiscal drag caused by reduced government spending, could keep economic improvement—and thus interest-rate increases—relatively modest.
The information provided herein is as of August 23, 2013.
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 provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®). Teachers Advisors, Inc., is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). Past performance is no guarantee of future results.
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