WILLIAM RIEGEL, CHIEF INVESTMENT OFFICER
February 13, 2015
It was a broadly positive week for equities. Optimism stemmed in large part from news of a cease-fire agreement between Russia and Ukraine and a pickup in oil prices, coupled with some positive economic surprises in Europe.
U.S. equities shrugged off weak domestic economic data and rising U.S. Treasury yields, with the S&P 500 Index posting a second straight week of gains and finishing at a new all-time high. Cyclical stocks have led the recent upturn, suggesting the market anticipates future economic improvements driven by consumption.
Stocks in Europe also gained ground, as Germany’s economy grew much faster than expected, fueling hopes for a broader economic recovery in the region. Chinese equities gained following three successive weeks of losses, as China’s central bank pumped another 160 billion yuan ($26 billion) into the banking system on February 11, adding to earlier stimulus. The key risk in China remains the fragile property market.
The yield on the bellwether 10-year Treasury, which moves in the opposite direction of its price, rose modestly during the week. Despite several disappointing U.S. economic releases, including declining retail sales numbers and higher jobless claims, brighter news out of Europe trimmed demand for safe-haven assets, pushing the 10-year yield above 2% for the first time in a month.
Returns for spread products, (higher-yielding, lower-rated non-U.S. Treasuries) were mixed. Positive fund flows supported returns for better-quality high-yield corporate bonds and emerging-markets debt, while returns for investment-grade corporate bonds were slightly negative.
The past week’s U.S. data releases were soft across the board, in line with our expectations for a slowdown in economic activity to start the year. The retail sales report, while disappointing at the surface, showed some signs of resiliency by consumers.
Eurozone GDP expanded by a greater-than-expected 0.3% in the fourth quarter of 2014, with Germany, the region’s largest economy, growing by 0.7%. Results for other major European economies were mixed: Spain also expanded 0.7%, but France (+0.1%) and Italy (+0%) could not keep pace. Greece’s economy contracted (-0.2%). Although GDP gains were modest, they provide a measure of optimism that fresh monetary stimulus from the European Central Bank, a weakening euro, and improvements in loan growth will hasten economic progress.
We are not overly concerned about the recent deceleration of U.S. economic activity. Our expectations are that key growth trends in the areas that matter most—payrolls, wages, and consumption—will continue. Capital expenditures by businesses should also pick up. We are maintaining our first-quarter GDP growth forecast at 2.5%, which is in line with the latest data.
For U.S. equities, sentiment is at a bearish level—often a precursor to a market upturn. Notably, in January, investors sought to rein in risk by withdrawing more than $17 billion from equity exchange-traded products and adding over $7 billion to fixed-income portfolios. Against this backdrop and with the S&P 500 at a new all-time high, we would not be surprised to see a correction of up to 10% in the coming months.
The standoff between Greece and its international creditors bears watching. Of particular concern is that an acceleration of deposit outflows from Greek banks could lead to Greece’s exit from the Eurozone. That, in turn, could result in a run on deposits in some of the region’s weaker economies, such as Spain, Portugal, and Italy. While elements of a potential compromise over Greece’s debt load have fueled market hopes for a quick agreement, we expect protracted and difficult negotiations.
In fixed-income markets, we see value in U.S. high-yield and investment-grade corporate bonds, commercial mortgage-backed securities, and select emerging-markets debt issued by oil importers. We will remain focused on conditions in the U.S. labor markets in order to assess the timing and scope of future interest-rate movements.
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.
Foreign stock market returns are stated in U.S. dollars unless noted otherwise.
Please note that equity and fixed income investing involve risk.