WILLIAM RIEGEL, HEAD OF EQUITY INVESTMENTS
December 19, 2014
In a highly volatile environment, U.S. equities rebounded from a seven-day, 5% correction to finish the week up more than 3%. Markets were initially driven lower by collapsing oil prices that some investors fear reflect a slowdown in global growth, and by news that the Russian central bank had hiked its overnight interest rate from 10.5% to 17% to defend the rouble, which has been plunging along with oil prices. The S&P 500 Index then surged on December 17 and 18, buoyed in part by stabilizing oil prices, generally positive economic data, and a Federal Reserve statement that reassured markets the Fed “can be patient” about raising interest rates.
These catalysts spilled over into European markets, which also posted a gain of about 3% for the week. In Japan, the Nikkei 225 Index rose about 1.5% for the week in the wake of Prime Minister Shinzo Abe’s decisive electoral win on December 14. In our view, it is now essential that Abe implement the major structural reforms necessary to combat deflation and jumpstart the economy. As always, the devil will be in the details. Chinese equities also moved higher, underpinned by market expectations of further stimulus. Economic activity in China appears to be bottoming, potentially leading to further gains in what remains a very cheap market.
For additional insights about Russia and oil prices, read this new analysis (PDF) by TIAA Global Investment Strategist Dan Morris.
Fixed-income markets were also highly volatile, as the confluence of Russian rouble depreciation and plummeting oil prices spurred demand for safe-haven Treasuries early in the week, while end-of-the year illiquidity exacerbated daily price moves. As the week wore on, stabilizing oil prices, the equity market rally, and the Fed’s press release eventually drove the 10-year U.S. Treasury yield slightly higher, to close the week at 2.17%.
High-yield corporate bonds moved in sympathy with equities, recouping recent losses. We don’t believe there will be as many defaults as the market seems to expect, given the opportunities for many energy-related high-yield firms to avoid them by adjusting capital expenditures or merging.
Current market updates are available here.
Although some of the week’s economic releases were disappointing, particularly in housing and manufacturing, the economy's trajectory has not materially changed. If GDP growth in the current quarter comes in at 3.0% or better, as we forecast, it will be the fifth quarter out of the last six in which the economy has grown at or above that level.
Greece and Russia add uncertainty to European equity markets
While we view European stocks favorably overall, we are mindful of two potential risks. First, if the Greek parliament fails to elect a new president, general elections will be required next year. That could lead to further equity market volatility, although we believe any downside risks are already reflected in the country’s stock prices.
Russia remains a bigger concern. Belligerent responses by President Vladimir Putin to stronger sanctions by the West could spill over into a broader European or NATO conflict and destabilize markets. The Russian economy, heavily dependent on energy exports, has already been hit hard by falling oil prices and a tumbling currency.
In the U.S., we forecast annual GDP growth of 3.1% in 2015, although lower oil prices—a boon to both consumers and businesses—could provide an upside surprise. Elsewhere, China's GDP growth may fall shy of 7%, while in Japan, the central bank is likely to deploy additional monetary stimulus. The ECB, similarly determined to skirt a recession in the Eurozone, is all but certain to launch QE in the first quarter of 2015.While the S&P 500 Index has reached the intermediate target level of 2,050-2,100 that we have been anticipating, we think a move to 2,150 next year is possible. However, volatility will become an increasingly prominent factor to contend with as we get closer to the Fed’s rate hikes.
In fixed-income markets, we expect the 10-year Treasury yield to reach 2.75% by the end of 2015, with demand from foreign investors and falling U.S. inflation expectations possibly capping the increase. Emerging-market and high-yield corporate bonds should to recover in the new year, but, as with equities, volatility is likely to remain elevated. This will present opportunities for active fixed-income managers.
Foreign stock market returns are stated in U.S. dollars unless noted otherwise.Please note that equity and fixed income investing involve risk.
© 2014 Teachers Insurance and Annuity Association of America-College Retirement Equities Fund (TIAA-CREF), 730 Third Avenue, New York, NY 10017