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Equities try to find their footing in a volatile week

William Riegel, Chief Investment Officer TIAA Investments

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October 14, 2016

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Equities

Global equities ended a choppy week on an upbeat note. Mixed economic news out of China, concerns over a December Fed rate hike, and sharp swings in oil prices combined to put investors on guard. However, some better-than-expected bank earnings on both sides of the Atlantic provided a late-week boost. Overall, financial stocks have shrugged off the negative headlines surrounding several global banks, benefiting instead from rising interest rates.    


In the U.S., the S&P 500 Index lost about 1.0% for the week, its second consecutive one-week decline. European equities, meanwhile, eked out a 0.1% gain (in local currency terms), after falling to a two-month low on October 13.

In Asia, China’s exports fell in September by 10% from a year earlier, following a 2.8% year-over-year contraction in August. Imports also declined in September, by 1.9%. In a bit of positive news, however, stronger-than-expected inflation data eased some concerns about the health of the world's second-largest economy.  For the week, Chinese equity markets rose by about 1%, while Japan’s Nikkei 225 Index was down slightly.

William Riegel, Chief Investment Officer, TIAA Investments

Bill


Article Highlights

Current updates to the week’s market results are available here.


Fixed income

U.S. Treasury yields continued their rise this week amid ongoing expectations for a Fed rate hike by year end. After beginning the week at 1.73%, the yield on the bellwether 10-year note edged up to 1.79% on October 13, its highest level since early June, before closing at 1.80% on October 14. (Yield and price move in opposite directions.)  


Returns for non-Treasury “spread sectors” ranged from slightly negative to modestly positive for the week through October 13, with investment-grade (IG) corporate bonds leading the way. The potential for higher yields is particularly valuable to banks and financial companies, which make up a significant portion of IG issuance. That is because rising rates tend to widen the gap between what banks charge on loans and what they pay for deposits.

More signs of strength from the U.S. labor market

In a light week for U.S. data releases, the job market remained a bright spot. The week’s other economic reports included some disappointing consumer and business sentiment results.

Outlook

Currently, we think equity investors may be better served by looking outside the U.S. International stocks are attractively valued relative to both the U.S. market and their own history. Additionally, the policy environment for equities remains friendlier overseas. Moreover, the very low yields on developed-market bonds outside the U.S. implies that investors may want to consider allocating more of their international assets to equities rather than to fixed income. The main risk to international stocks, in our view, continues to be sluggish growth coupled with the premature removal of accommodative policy by central banks in Europe and Japan. Markets will seek clarity from the European Central Bank (ECB) at its October 20 meeting. Rumors have surfaced that the ECB might begin tapering its bond purchases before next March, when its quantitative easing program is scheduled to end.


In fixed-income markets, overseas demand for IG bonds may subside somewhat as interest rates rise in Europe. At the same time, demand for these securities may hold up better than that for U.S. Treasuries; the higher yields available on IG debt help cover the costs of hedging dollars into local currencies. Meanwhile, with default levels near cyclical lows, we continue to find value in higher-quality high-yield bonds and leveraged loans.

As for the Fed, investors will remain in suspense until December, although we still expect a 25 basis point (0.25%) increase in the benchmark fed funds rate. If such a move is followed by a series of gradual rate hikes, markets should be able to adjust accordingly, absent exogenous shocks.


The U.S. economy appears to have accelerated in the third quarter, helped by a more balanced mix of growth than the second quarter’s consumption-driven pickup and steep inventory decline. We still anticipate annual growth in the 2%-2.2% range as the U.S. enters a more mature phase of the economic cycle.

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