WILLIAM RIEGEL, INVESTMENT OFFICER, TIAA-CREF ASSET MANAGEMENT
August 8, 2014
Favorable economic data and better-than-expected earnings releases were among the positive factors tempering U.S. stock price declines. More than 75% of S&P 500 companies that have reported second-quarter results so far have beaten estimates (typically, the percentage is 60%). Earnings growth has averaged 10% for the quarter, versus original estimates of 5%.
The U.S. economy continues to improve, highlighted in the past week by a number of positive data releases:
Nonetheless, we have not changed our expectation for 1% GDP growth across Europe for 2014, and we expect conditions to stabilize as the year progresses. The primary risk to this forecast is the Russia-Ukraine standoff. Tit-for-tat sanctions could slow growth across the continent, and a severe or protracted trade war could push the entire region into recession. That said, there is still time for cooler heads to prevail, and most sanctions thus far have been moderate. Moreover, we continue to believe that if the eurozone economy were to slip further, the European Central Bank would initiate some form of quantitative easing to jolt the region out of its economic doldrums. That would likely trigger a sharp rise in European equities.
In China, a July surge in export growth and an unexpected drop in imports helped the Shanghai market close the week on a high note after a three-day losing streak. In contrast, Japanese equities sold off to end the week. Exporters led the decline, as the yen—typically seen as a safe-haven currency—strengthened in response to geopolitical events. (A stronger yen makes Japanese products more expensive in overseas markets, hurting exporters.)
Historically, stock prices have corrected five months in advance of the Fed’s first move to raise interest rates. While the simple onset of tightening does not automatically lead to the end of a bull market, volatility does rise, and the subsequent rate increases eventually lead to the end of the cycle—hence, the market’s fixation on the timing of that first rate hike. We continue to believe that the Fed will not begin raising rates until mid to late 2015.
We have been encouraged by the general resilience of the U.S. equity market. Recent volatility has not been driven solely by broad-based risk aversion to macroeconomic and geopolitical events—although that certainly is a factor. Instead, we have seen small caps beginning to outpace large caps, as well as rotations out of sectors that have outperformed during the Fed’s long period of quantitative easing. For example, higher-yielding sectors such as Utilities have recently sold off more than others, which is unusual in a declining market.
In fixed-income markets, the general dislike of uncertainty is currently in play, as the varying potential outcomes of current geopolitical events remain unknown. Many institutional fixed-income fund managers have been inclined to realize their year-to-date gains and to sit on the sidelines until there is further clarity. In this environment, we have seen high-yield spreads widen, exacerbated by limited summertime liquidity. We believe spreads are poised to widen further but that at least a partial recovery is likely later in the year.
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.
Foreign stock market returns are stated in U.S. dollars unless noted otherwise.
Please note that equity and fixed income investing involve risk.
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