William Riegel, Chief Investment Officer TIAA Public Investments
March 24, 2016
In a week of light trading shortened by the Good Friday holiday, the S&P 500 Index hit a patch of volatility and edged lower—an unsurprising result, given the index’s nearly uninterrupted surge of more than 12% from its February lows. The S&P 500 has been buoyed by rising oil prices and a resumption of corporate buybacks, which were suspended earlier in the year due to the buyback “black out” period. (Corporate stock buyback programs are halted during the five-week period leading up to earnings season.) Oil prices, however, fell about 4% for the week through March 24, after breaching $40, a key psychological level, during the previous week.
Stocks in Europe displayed a measure of resiliency in the face of the terrorist attacks in Brussels but still declined 1.9% in local currency terms. On a positive note, the Eurozone services and manufacturing sectors regained some momentum in March, after slowing for two months.
Emerging markets have recently been in better form than their developed-market counterparts. As of March 23, they were more than 20% higher than their January bottom and up 11+% for the month to date, according to the MSCI index. A number of factors have fueled the upswing, including a revival in materials and energy stocks, a calmer outlook for China’s currency (the yuan) and economy, and a weaker dollar. These gains could reverse, however, if China enters another currency devaluing phase, which in the past has unsettled markets.
William Riegel, Chief Investment Officer, TIAA Investments
Current updates to the week’s market results are available here.
Fixed-income assets were largely unaffected by the attacks in Belgium, a sign that investors may have become inured to these tragic events. The yield on the bellwether 10-year U.S. Treasury began the week at 1.88% and hovered around that level on March 24. Returns for non-Treasury “spread” sectors were broadly, if minimally, negative, although investment-grade corporate bonds bucked that trend with a modest gain.
While still subdued, manufacturing and service-sector activity expanded, while the labor market remained a source of strength. Among the week’s reports:
Although we believe the S&P 500 Index could move to and through its previous high of 2,134 over the next 12 months, we would not be surprised by a near-term correction. Despite the terrorist attacks, rising stock prices have pushed some gauges of investor sentiment into positive territory—a contrarian indicator that has often presaged a market decline. Moreover, share buybacks will cease again as the first-quarter earnings period begins, removing one of the equity rally’s major catalysts.
In our view, the recent rise in equity prices represents a genuine move up and is not part of a bear-market rally. Moreover, a pullback, should one occur, would present attractive buying opportunities. U.S. economic activity is improving, the dollar has been trending weaker—which should help reverse last year’s currency hit to corporate earnings—and the Federal Reserve has tempered its expectations for rate hikes in 2016.
Europe, meanwhile, likely offers even more upside potential than the U.S. The region’s stocks are undervalued compared to U.S. shares, and the European Central Bank’s recent injection of fresh monetary stimulus is evidence of its focus on jumpstarting growth. A possible red flag is Great Britain’s June 23 voter referendum on whether to exit the European Union.
For the U.S. economy, we expect a pickup in activity this quarter and next, with first-quarter GDP reaching 2.2%. That should provide scope for an interest-rate hike in June, although the Fed may hold off if market volatility returns. A December hike will depend greatly on the economy’s continued improvement, specifically growth in wages, income, and consumption. We think inflation will play a smaller role in rate-hike calculations than it has in the past, as the Fed has suggested that it will allow inflation to overshoot its 2% target in the near term.
In fixed-income markets, we believe the bulk of the rally in credit markets is likely behind us. Non-Treasury spread sectors could well trade within a narrow range over the next few weeks as investors await additional U.S.-centric data. Overall, commercial mortgage-backed securities have lagged the recovery but may yet rebound, whereas lower rated (CCC) high-yield bonds—another recent underperformer—are unlikely to do so.
High-yield and leveraged loan prices no longer reflect the risk of a recession. At the same time, continued weakness in oil prices will trim some of the gains made by high-yield debt, as approximately 20% of the asset class consists of energy companies. Meanwhile, a strengthening of the dollar would foreshadow higher funding costs for emerging-markets debt, which would weigh on returns.
TIAA Global Asset Management provides investment advice and portfolio management services through Teachers Insurance and Annuity Association and affiliated registered investment advisors, including Teachers Advisors, Inc., TIAA-CREF Alternatives Advisors, LLC and Nuveen Asset management, LLC.
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