WILLIAM RIEGEL, CHIEF INVESTMENT OFFICER
May 8, 2015
April’s solid jobs release salvaged the week for U.S. equities. The S&P 500 Index was down nearly 1% for the week through May 7, hurt by a surge in U.S. Treasury rates. The index rebounded on May 8, however, as investors saw the monthly payrolls report as strong enough to suggest improved economic footing following a weak March, but not so robust that the Federal Reserve would significantly accelerate its tightening timetable.
European equities also rose despite severe volatility in Eurozone bond markets and ongoing concerns about Greece. A better-than-expected showing for the Conservative Party in U.K. elections helped, reducing political uncertainty and increasing the likelihood of policies perceived as more market-friendly.
Global fixed-income markets were volatile. In Europe, the spike in yields that followed a failed German bond auction in late April continued during the past week. Germany’s 10-year yield hit 0.80% early on May 7 before settling below 0.60% the next day. Better economic data and heightened inflation expectations fueled the sharp jump in yields, while continued bond buying by the European Central Bank (ECB) helped stanch further increases.
U.S. Treasury yields also rose. After beginning the week at 2.12% and reaching 2.25% on May 7—the highest level in more than four months—the yield on the bellwether 10-year note closed at 2.16% on May 8, in part because April’s jobs report included a downward adjustment to March’s jobs data, indicating a greater degree of labor market weakness than previously thought.
Although “spread products” (higher-yielding, non-U.S. Treasury securities) posted negative returns for the week through May 7, they were surprisingly resilient compared to their performance during the rise in rates that marked the May 2013 “taper tantrum.”
The U.S. economy created 223,000 jobs in April, roughly in line with or only slightly below most forecasts. Additionally, March’s already modest total (+126,000) was adjusted downward, to 85,000—a surprise given our expectation for an upward revision, and further evidence that the month was far weaker than we had anticipated. Meanwhile, the unemployment rate edged down from 5.5% to 5.4%, its lowest level since 2008. Wage growth rose by just 0.1% in April and 2.2% over the past 12 months. In our view, this report will not provide the impetus for the Fed to raise rates at its June meeting, so a September time frame remains the odds-on favorite.
Among the week’s other releases:
Economic data out of the Eurozone was largely positive. The region’s manufacturing sector slowed in April but remained in expansion territory, while the European Commission lifted its growth forecast for the Eurozone from 1.3% to 1.5% amid cheaper oil, a weaker euro, and aggressive quantitative easing by the ECB. Countries that have made the greatest efforts toward reforms (such as Ireland and Spain, which reported plummeting unemployment in April) have shown the most improvement.
The past week’s equity market volatility is to be expected as the market begins to price in a hike in the federal funds rate and an eventual normalization of the overall interest-rate environment. In our view, expected returns for U.S. equities relative to bonds remain attractive, although that would change if the yield on the 10-year Treasury were to breach 3%. We don’t believe such a rate increase will occur this year, however, given the moderate pace of recovery in the U.S. and continued demand for Treasuries from investors seeking higher yields than those available in Europe.
Sentiment levels could also support higher equity prices, as both short- and long-term measures remain firmly in negative territory, a potential precursor to a market rise. At current price-to-earnings (P/E) ratios of 17x-18x earnings, stocks are not cheap, but their valuations are well below historical highs (25x-35x earnings) that often accompany overly optimistic sentiment.
In fixed-income markets, we think U.S. yields will remain tied to global events, including inflation/ deflation trends and shifts in sentiment. U.S. debt appears reasonably priced at current levels, with a bias toward higher rates by year-end.
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.
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