March 27, 2015
U.S. equities failed to extend their recent Fed-inspired rally, when markets rose on the assumption that short-term interest rates will not be hiked until later this year. For the past week, the S&P 500 Index fell more than 2% amid a bump up in oil prices driven by escalating hostilities in Yemen, coupled with higher interest rates.
European stocks also lost ground, snapping a seven-week winning streak. A rebound in the euro, combined with a bout of risk aversion given Middle East tensions, contributed to the pause. We believe the region’s brightening economic prospects continue to offer the opportunity for favorable returns.
Japan’s manufacturing sector slowed in February, while activity in China’s factories contracted. Investors may take this weak economic news as a sign that more central bank stimulus is forthcoming, providing future support for equity markets. In local currencies through March 26, Japan’s Nikkei 225 Index and Shanghai’s “A Share” index were up about 12% and 14%, respectively, trailing Europe (+17% in local currencies).
In Europe, concerns about the future of Greece’s bailout package and a possible Greek exit from the eurozone have not spread to fixed-income markets. Eurozone sovereign debt continues to rally, with the decline in yields most pronounced among longer-dated bonds.
February’s economic releases, although on the weak side, were slightly better than January’s, and we see some hints of acceleration. This bodes well for economic growth in the second quarter and second half of the year.
Among the past week’s reports:
Meanwhile, the government’s third and final estimate of fourth-quarter GDP growth (+2.2%) was unchanged from the previous estimate.
Against this positive backdrop are the ongoing problems plaguing Greece. The new government is scheduled to deliver a detailed package of economic reforms to Eurozone officials on March 30 in the hope of unlocking financial aid and avoiding bankruptcy. Greece’s previous list of planned reforms was criticized for being too vague. Therefore, creditors will demand greater detail before agreeing to release any funds. To address the potential for a run on Greek bank deposits, Athens may be forced to consider imposing capital controls over the next few weeks.
In the near term, the path of the S&P 500 Index may well be determined by results of the upcoming first-quarter earnings season. Recent revisions have been negative, although the market has previously attributed lower-than-expected earnings to the stronger dollar and, in some cases, bad weather. Additional volatility is to be expected, as markets have historically exhibited wide price swings in anticipation of Fed interest-rate hikes.In fixed-income markets, fundamentals remain stable to positive. High-yield bond default expectations remain low (outside of energy companies), and mergers and acquisitions activity in the investment-grade corporate bond space is still modest compared to long-term averages. However, any number of upside economic surprises could trigger a rise in yields, as markets fear that better economic news could hasten the Fed’s tightening timetable. We believe the odds of the initial rate hike happening either in June or in the third quarter are evenly split. In the meantime, we continue to monitor movements in 2- and 5-year Treasury yields, which tend to rise significantly between one and three months prior to the Fed’s first hike in a new rate cycle.
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.
© 2015 Teachers Insurance and Annuity Association of America-College Retirement Equities Fund (TIAA-CREF), 730 Third Avenue, New York, NY 10017