William Riegel, Head of Equity Investments
Lisa Black, Head of Global Public Fixed-Income Markets
March 15, 2013
Equity markets sustained a progressive climb during the week, reaching new highs as the Dow Jones Industrial Average marked a ten-day stretch of positive closes through Thursday—the longest such unbroken series for the Dow since 1996. While market trading remained somewhat uneventful during the week, the primary driver of market performance centered on positive U.S. economic data indicating continued traction in labor markets and resilient consumer spending. Benefiting most in this climate were economically sensitive sectors such as Consumer Discretionary, Financials, and certain industries such as homebuilders. On a quarter-to-date basis, domestic equities have gained nearly 10%, while foreign developed-market equities are up approximately 4.5% and foreign emerging markets are down slightly.
In fixed-income markets, Treasury yields declined slightly during the week, resulting in modest gains. Investment grade and high-yield corporate bonds benefited more strongly from an improving economic outlook. Investors are showing a clear preference for floating rate high yield loan funds over bond funds, likely reflecting a degree of interest rate risk concerns. Fund flows into investment grade bonds remain strong, however, with many retail and institutional investors viewing the risk of rising rates as manageable.
Consumer resilience mitigates tax concerns
A stronger-than-expected retail sales report for February marked the biggest gain in five months and relieved some concerns that consumers would restrict spending as higher gas prices, increased payroll taxes, and delayed tax refunds have pressured consumer budgets. Patterns in spending suggest that wealthier consumers made up for declines in spending from lower income consumers. However, the sustainability of further growth in retail sales will likely depend on further declines in savings rates, which have already fallen to low levels. Additionally, Friday’s University of Michigan consumer confidence index reading came in lower than expectations, which may provide a headwind for spending.
Labor market improvements support extended market gains
Also boosting investor confidence this week was a decline in initial jobless claims, representing one of the lowest such readings in the past five years. We noted last year that up to one million new housing jobs were possible on recovery and we are beginning to see them come through.
These improvements are supportive of expanding margins for most corporate players via rising aggregate discretionary income and have been feeding the equity rally as well as the ongoing rally in high-yield debt. This virtuous scenario can and should run longer until such time as markets can sense a reduction in Fed support.
Based on stable producer prices, inflation that remains within an expected range, and unemployment levels above the Fed’s target, we believe that a reversal in accommodative Fed policy is not likely at this point. For now, we can continue to watch the economic healing take place knowing the Fed wishes to see it continue for quite some time.
International markets show progress despite concerns
While economic and financial market conditions outside of the U.S. do not mirror the steady stream of favorable news that has propelled domestic markets, international markets nonetheless benefited from an improving U.S. outlook. Despite overhanging concerns regarding Italy’s lack of a functional governing body, European markets trended modestly higher for the week, shrugging off sovereign debt and growth-related concerns for the time being. In China, stocks fell to a two-month low on concerns over weak economic data and an uptick in inflation.
As short-term trading sentiment remains very bullish, we continue to be concerned about the risk of a market correction. So far, however, this fear has been misplaced, and low current equity allocations combined with a tempering of long-run pessimism over equities may represent a source of “reserve” investor buying power that could continue to propel markets forward. Supporting this view has been a reversal in equity mutual fund flows, which have turned positive for the first time in seven years.
Equity valuations remain in a reasonable range, but are edging toward expensive. Although corporate earnings have been respectable, current market levels reflect expectations for substantial earnings growth in the second half of the year. Additionally, while equities may appear compelling based on a substantial risk premium offered over fixed income, this premium has been compressing and is somewhat artificially high due to current low interest rates.
While these issues will likely come into play as the year progresses, over shorter-term time horizons it may pay to go with the momentum.
The information provided herein is as of March 15, 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 and fixed income investing involve risk.