WILLIAM RIEGEL, HEAD OF EQUITY INVESTMENTS
LISA BLACK, HEAD OF GLOBAL PUBLIC FIXED-INCOME MARKETS
December 13, 2013
After marking a new high on Monday, December 9, the S&P 500 Index reversed course and declined in the latter half of the week. The sources of weakness were many, including:
For the week to date through December 12 the S&P was down nearly 2%. Foreign developed- and emerging-market stocks fell by a similar amount, based on MSCI indexes.
Fixed-income returns were generally flat during much of the week, although certain “spread sectors” (higher-yielding, non-U.S. Treasury securities) showed relative strength, including investment-grade and high-yield corporate bonds, as well as emerging-market debt. The yield on the bellwether 10-year Treasury note crept higher during the week, closing at 2.89% on December 12.
Current market updates are available here.
Improving retail sales highlight the week’s U.S. data releases
Data released during the past week offered evidence of improving conditions in the U.S. economy, once again prompting market concern that the Fed is poised to pull the taper trigger at the conclusion of its Federal Open Market Committee (FOMC) meeting on December 18. Among the releases were retail sales, which have improved markedly since September:
Other data reminded us that economic performance remains somewhat uneven. Inflation was flat to negative in November, an indication of lukewarm demand in the economy. In addition, first-time unemployment claims spiked to 368,000, a level we should not be seeing at this stage of the recovery. On balance, the week’s releases were in keeping with our forecast for fourth-quarter GDP growth, which remains unchanged at 2%.
Europe continues to face challenges
Europe is a source of increasing near-term concern:
Chinese stocks move lower, but economic releases are encouraging
Chinese equity markets moved lower during the past week on concerns that policymakers will cut expected GDP growth rates from 7.5% to 7%. Meanwhile, real-time economic data out of China has been very good. Vehicle sales grew 16%, bank loans 14%, money supply (M2) 14%, retail sales 14%, and industrial production 10%.
The reported budget deal in Washington, while narrow in scope, eases near-term gridlock and provides fiscal clarity for the next two years. This will likely boost confidence and stimulate both consumer spending and corporate investment, each of which has been subdued despite a favorable macro backdrop.
There is very little consensus as to when Fed tapering will begin, although a strong case can be made for either December or March. As of this writing, we think there’s a 50/50 chance that either will occur. Regardless of the timing, we continue to believe that market apprehension about tapering is disproportionate to the actual impact it will have. Moreover, assuming the Fed provides clear forward guidance as expected, we think equity markets will respond positively.
We are not alarmed by what appears to be a normal mid-cycle correction for U.S. equities. As we have noted before, the S&P 500 is long overdue for a pullback of 5% or more. Whether now is the time for this to occur remains to be seen, as December is typically a seasonally strong period for stocks. We continue to anticipate new market highs for equities in 2014, but with heightened volatility.
Despite recent losses, European equities remain on track to deliver favorable returns for 2013 as a whole. Valuations remain cheap and risk premiums are wide, but we are concerned about further downward pressure on stock prices. The market has already corrected more than 5% and could extend that to 10%.
In fixed-income markets, some of the recent rally in spread sectors reflects a continued decline in the supply of new issues against fairly stable demand. However, there is also an underlying sense that, while bond markets may be more challenged than equities in the months ahead, it is still possible to find attractive value, particularly if investors are cautious about their duration exposure. (Duration is a measure of a bond’s sensitivity to changing interest rates, with shorter-term securities generally less vulnerable to sharp price declines when rates rise.)
Many investors will continue to benefit from allocating a portion of their portfolios to fixed income. As Fed liquidity is gradually withdrawn, however, we are likely to see a new set of fixed-income outperformers, including investment-grade corporate bonds, which have rebounded after lagging for much of the year and may be poised to continue their recent outperformance in what we expect will be a gradually (rather than rapidly) rising interest-rate environment. Overall, we will continue to focus on asset allocation across fixed-income sectors while also seeking to add value through individual security selection.
The information provided herein is as of December 13, 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.