WILLIAM RIEGEL, CHIEF INVESTMENT OFFICER
April 10, 2015
U.S. equities edged higher during the past week, supported by signs of an improving economy and mergers and acquisitions (M&A) activity. Stocks also got a lift when minutes from the Federal Reserve’s March meeting, published on April 8, revealed diverging viewpoints among Fed officials over when to begin raising interest rates. Markets now believe that “liftoff” will begin in September rather than in June.
European stocks, meanwhile, surged to a 15-year high during the week, also buoyed by indications of economic improvement and optimism over M&A deals. Adding to the positive mood was relief that Greece had met a deadline to repay €460 million to the International Monetary Fund. In Japan, the Nikkei 225 Index extended its rally, and on April 9 briefly surpassed the key 20,000 level for the first time since 2000. The Nikkei’s gain for the year (almost 14%) has been underpinned by increased Japanese pension portfolio allocations and, more recently, by inflows from retail investors.
Treasury prices dipped in response to the week’s solid economic reports. The yield on the bellwether 10-year note, which started the week at 1.85%, hovered around 1.95% in afternoon trading on April 10. (Price and yield move in opposite directions.)
Returns for “spread products” (higher-yielding, lower-rated non-U.S. Treasury securities) were flat to slightly negative, although high-yield bonds once again bucked the trend, supported by another week of strong inflows. Year to date through April 9, U.S. high yield (+3.30%) has handily outpaced both the broad investment-grade bond market (+1.63%) and the S&P 500 (+2.14%).
With the weather-depressed first quarter finally behind us, it appears that U.S. economic activity is normalizing, as we expected. Among the week’s reports:
In the Eurozone, manufacturing and service-sector activity improved in March to an 11-month high, according to Markit’s Composite PMI for the region. In addition, a closely watched index of investor sentiment published by Sentix increased for the sixth straight month in April, to its highest level in almost eight years, reflecting greater confidence amid the European Central Bank’s quantitative easing program and the weak euro. Moreover, German exports rose in February after dipping in January.
There was positive news out of Greece, too, including better-than-expected industrial production and a €460 million ($494 million) debt payment to the International Monetary Fund on April 9. The nation’s precarious financial condition persists, however. Greek bank deposits continue to shrink, and there are some large upcoming debts over the next few months that the government may not be able to repay without further assistance from its international creditors.
For U.S. equities, higher inflation expectations and better economic news are buttressing cyclical and small-cap shares. For example, after bottoming in October 2014 and starting slowly in 2015, the small-cap Russell 2000 Index is up 4.86% year-to-date through April 9, more than double the 2.14% return for the S&P 500 Index. However, given single-digit earnings growth, U.S. equity valuations are stretched, while investor sentiment is creeping closer to overly optimistic levels. Therefore, we would not be surprised by a correction on the S&P 500. Likewise, the run-up in European equities makes them susceptible to a pullback as well.
Regarding the U.S. economy, the Job Openings and Labor Turnover Survey (“JOLTS”) was positive, suggesting that the disappointing March employment report deserves a re-evaluation. We expect an upward revision to last month’s payrolls and a quick recovery in jobs growth. Additionally, while we still believe the overall economy will begin to accelerate in the second quarter, we are feeling less confident about first-quarter GDP. Although our forecast for Q1 growth remains at 1.5%, the potential for a downside surprise has increased.
Outside of the U.S., China remains a primary concern, as economic activity continues to weaken. The government has been administering targeted stimulus, and recently the central bank cut its deposit and lending interest rates by 25 basis points (0.25%) to provide support for the cooling economy. Chinese equity markets have risen in response to these moves, but caution is warranted.
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.
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