William Riegel, Head of Equity Investments
Joseph Higgins, Portfolio Manager, Global Public Fixed-Income Markets
September 21, 2012
U.S. equity markets maintained the high levels achieved by last week’s rally, which was triggered by the Federal Reserve’s announced third round of quantitative easing (“QE3”). Market activity was characterized by light trading and somewhat muted responses to developments that included additional easing from the Bank of Japan, concerns over Spain’s reluctance to request a bailout, and mixed economic news in the U.S.
Defensive sectors led the markets, with consumer staples and utilities outperforming more economically sensitive sectors such as industrials, financials and energy. Domestic stocks, while down slightly for the week as of September 20th, outperformed international stocks, which realized steeper declines based on global growth concerns. These concerns continue to be a primary focus in developed and emerging international markets.
Fixed-income markets reflected a shift to more defensive positioning, as yields required for riskier credits increased while yields on safer U.S. Treasuries declined throughout the week. Part of this movement reflected a modest retraction of last week’s strong gains in mortgage-backed securities, which had fully priced in the Fed’s ongoing QE3-related purchases in that sector. High-quality corporate bonds did very well under prevailing conditions, as did Treasuries, as the 10-year Treasury yield declined from 1.88% to 1.79% as of September 20th.
Focus in U.S. remains on direction of economy
While signals remain mixed in the U.S., overall indications point to a rebound from the 1.7% GDP growth registered in the second quarter back to 2%-plus trend-line growth.
Positive indications include:
Negative indications include:
Although improved housing activity indicates that housing markets are continuing their recovery, this nascent strength has not yet appeared in employment numbers. The Fed’s hope is that lower interest rates will lead to more refinancing, home sales and home-related expenditures, which could boost employment over time. Additionally, higher home prices, which have increased by 10% on a year-to-date basis, are expected to bolster consumer confidence via the "wealth effect." This can lead households to become more willing to use savings for discretionary purchases, thereby boosting GDP. As the turnaround in housing prices and additional stimulus measures are recent developments, the anticipated effects will take time to filter through to broader measures of consumer activity and economic growth.
Economic headwinds and upcoming budget announcements loom for Europe
Prospects for improvement in Europe have been bolstered in recent weeks by several developments, including:
Despite these positive developments, Spain’s reluctance to request a bailout, as well as renewed uncertainty over the implementation of a single supervisory mechanism for eurozone banks have emerged as items of concern. Additionally, declining measures of business confidence and a strengthening euro represent additional headwinds for the eurozone economy.
Anticipated developments in Europe next week could represent potential triggers that may lead to a short-term correction in European markets and beyond, including:
Bank of Japan announces stimulus and China struggles to improve growth
The Bank of Japan surprised markets during the week with quantitative easing measures intended to stimulate the country’s sluggish economy. These measures will likely lead to depreciation in the value of the yen, thereby increasing the competitiveness of Japan’s exports. As a result of quantitative easing programs now in effect in Europe, Japan and the U.S., capital is likely to flow to emerging markets that offer higher interest rates. This will likely place pressure on emerging markets to limit appreciation of their currencies, which is often accompanied by a reduction in exports.
Along with other Asian economies, China continues to struggle to implement effective measures to boost growth. A preliminary survey of manufacturing activity for September indicates continued contraction, as has been the case for 11 straight months. New measures announced to reverse slowing will likely be accompanied by the release of stimulus funds that were previously held up by government transition issues, which may allow activity to reaccelerate meaningfully in the first half of 2013. Investors in Chinese markets remain unmoved by that prospect for the time being, as evidenced by steep declines realized by the Shanghai Composite during the week.
Based on the strong run-up in markets in recent weeks, the S&P 500 has moved to within 7% of its 2007 peak, reflecting high levels of optimism and a strongly bullish sentiment that may leave U.S. equity markets vulnerable to a short-term correction. By comparison, the MSCI Europe Index has advanced a world- beating 24% since hitting a June 1st low, but still remain 72% below the 2007 peak. Despite the very strong move by European equities, they remain relatively cheap and have, in our opinion, significant upside potential assuming the EU holds together and growth resumes.
Within fixed-income markets, we consider conditions to be supportive of spread sector credits, which may outperform in a continued slow-growth environment. Moreover, we remain encouraged that improvements in housing market activity, against a backdrop of stepped-up stimulus in the U.S. and abroad, will result in improving global growth conditions into next year.
The information provided herein is as of September 21, 2012.
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.
Please note that equity investing involves risk.