William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets
February 1, 2013
U.S. equity markets climbed higher during the past week and for the month of January, driven primarily by improving economic activity and generally favorable corporate earnings releases. January’s market advance was led by mid caps (+6.8%) and small caps (+6.3%), and by a continued preference for value (+6.5%) over growth (+4.5%), as measured by the respective Russell indexes. The S&P 500 Index gained 5.2% for the month, getting the year off to a very strong start. Foreign developed- and emerging-market equities also rose in January, with the MSCI EAFE and MSCI Emerging Markets indexes up 5.3% and 1.4%, respectively.
Fixed-income markets, however, grew increasingly concerned that a more rapid economic recovery in the U.S. could cause the Federal Reserve to end its quantitative easing (QE3) program sooner than previously anticipated, causing a potentially accelerated rise in interest rates. The Barclays U.S. Aggregate Bond Index posted a slightly negative return (-0.7%) in January, weighed down by longer-term U.S. Treasuries (-3.9%). As Treasury prices fell, their yields rose. During the past week, the closing yield on the bellwether 10-year Treasury breached the 2% threshold for the first time since April 2012, while the 30-year yield rose above 3.2%. Meanwhile, high-yield bonds have continued to outperform, returning 1.3% in January as increased demand drove their prices higher and yields lower.
Despite mixed headlines, U.S. economy remains on growth trajectory
At first blush, some of the key U.S. economic data released during the past week appeared somewhat discouraging:
Many other U.S. economic indicators were positive:
On balance, U.S. data releases confirmed that the underlying private economy is healthier than some headlines would suggest. That said, U.S. economic reports are no longer “surprising” to the upside relative to consensus forecasts, as evidenced by a downturn in the Citigroup Economic Surprise Index over the past several weeks.
More of the same from Europe and China
The past week brought more signs of stabilizing conditions in Europe and stronger growth in China.
Globally, the manufacturing sector expanded to a 10-month high of 51.5 in January, as measured by the JP Morgan Global PMI. Significant contributions came from the U.S., Mexico, China, Brazil, and other emerging markets. Of concern is that improving global economic momentum has led to rising commodity prices. Oil in particular has advanced sharply from its most recent lows, putting an added burden on consumers, who are paying 30 cents more per gallon at the gas pump than they were two months ago.
Other risks that could drag on the markets include a rekindling of European fears (Italian elections are set for late February), the ongoing U.S. fiscal debate, and increasing noise about currency “wars,” as seen with Japan’s recent focus to weaken the yen in order to fuel export growth.
The most recent data releases continue to point to strengthening fundamental demand in the U.S. economy, tempered by a degree of uncertainty. Against this backdrop, U.S. equities remain relatively cheap in our view, although short-term trading sentiment has arguably reached overly optimistic levels — which could in turn set the stage for a period of market weakness or at least a sideways pattern.
However, because fear of such a correction has become widespread, a true market “surprise” would be a continuation of the recent advance or a sideways pattern that supports reasonable returns from individual stock selection. A favorable sign is that intra-stock correlations in the U.S. have fallen sharply, which means returns have become less subject to broad market moves and more tied to earnings and other company fundamentals.
In fixed-income markets, flows continue to be positive for investment-grade and high-yield debt funds, but we increasingly see greater momentum for flows into equity and floating-rate loan funds. A further pick-up in equity flows, and/or a substantial rise in longer-term Treasury yields, has the potential to spark a significant flight from high-quality corporate funds to equities.
Overall, the bond market is taking its cues from economic releases more so than it has in recent years, as each data point may offer a glimmer of insight as to when and if the economy reaches a level of employment growth that will cause the Fed to reduce its extraordinary stimulus measures. While the probability of a sharp rate spike is currently low, a few months of robust employment growth could raise the odds of that outcome.
The information provided herein is as of February 1, 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.
Please note that equity investing involves risk.