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Is there a doctor in the house? Concerns over healthcare bill weaken U.S. equities

Brian Nick, Chief Investment Strategist, TIAA Investments

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March 24, 2017

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Quote of the week

"You take it on faith, you take it to the heart. The waiting is the hardest part.”—Tom Petty


The Lead Story: It still pays to look small

By returning 21.3%, the small-cap Russell 2000 Index enjoyed a banner campaign in 2016, easily outpacing both mid- and large-cap stocks after lagging during the previous two calendar years. Most of that gain (16.5%) came during a pre- and post-election rally, when small caps rose for 14 consecutive days to a series of record highs. With their domestic focus, smaller companies surged amid expectations for corporate tax relief, stronger economic growth, and a rising dollar under the Trump administration. (A strong dollar hurts sales and profits of larger-cap multinationals by making their exports more expensive in overseas markets.)

Brian Nick, Chief Investment Strategist, TIAA Investments

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Article Highlights

Congressional action on tax reform, however, may have to wait until lawmakers finally hammer out a new healthcare bill. And the U.S. Dollar Index, which measures the value of the dollar against a basket of foreign currencies, has fallen 2.5% for the year to date through March 22. With these supports weakened, small caps have delivered flat returns in 2017, while the broader S&P 500 Index has gained 5.3%.

Despite this lag, we still believe investors can benefit from a strategic allocation to the small-cap asset class. Although past performance is no guarantee of future results, research has consistently shown that over the long term, including small-cap stocks as part of a broad asset allocation has improved portfolio returns on a risk-adjusted basis.
 

In other news: One bad day sends the S&P lower for the week

The S&P 500 declined 1.2% on March 21, a modest drop by historical standards but the first time the index lost 1% or more in a single trading day since October 11, 2016. A 2.9% plunge by Financials stocks was the major culprit for the poor performance, but investors also began to worry that the healthcare reform bill, scheduled for a House vote on March 22, would fail.


When the vote was postponed due to opposition among some Republican factions, the VIX—or so-called “fear” index, a measure of implied volatility in the S&P 500 Index—jumped to its highest level of the year, while still remaining well below its historical average. For the week, the S&P 500 lost 1.4%—its worst one-week showing since the week of October 31, 2016.

Why are equity investors monitoring the healthcare vote? Broadly speaking, they fear that if President Trump is unable to “repeal and replace” the Affordable Care Act—a core theme of his campaign—then the rest of his pro-growth agenda, which has fueled the S&P 500’s post-election rally, may be delayed. In Europe, the broad STOXX 600 Index rose just 0.1% (in U.S. dollars), as U.S. healthcare jitters kept a lid on gains.  

Meanwhile, U.S. Treasury yields continued to decline, reflecting concerns that the Trump administration’s plan for fiscal stimulus may disappoint markets. After beginning the week at 2.50% and rising as high as 2.62% just prior to the Fed’s March 15 meeting, the yield on the bellwether 10-year note closed at 2.41% on March 24. (Bond yields and prices move in opposite direction.) We believe the Treasury market has not focused on a potential slowdown in the U.S. economy, even though first-quarter GDP growth could disappoint. In fact, the Atlanta Fed’s GDPNow tracking measure has dropped from 3.4% in early February to just 1% as of March 24.


Returns for non-Treasury “spread sectors” were mostly positive for the week through March 23, led by investment-grade corporate bonds. Their high-yield counterparts, fresh off a series of steep weekly outflows, lost ground.

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

Below the fold: A quiet week on the U.S. economic data front

Markets paid little heed to this week’s batch of mixed data releases. Among the reports:  

  • Existing home sales edged down 3.7% from January’s 10-year high. Even though foot traffic remained strong, tight inventory and rising home prices stifled purchases. According to the National Association of Realtors, the median existing-home price in February jumped 7.7% from a year ago, the 60th consecutive month of year-over-year gains.
  • At the same time, new home sales soared 6.1% in February, to their best pace in seven months, and were 12.8% higher versus last year. 
  • Weekly jobless claims climbed by 15,000 to 258,000, matching a two-month high. The less volatile four-week moving average, however, ticked up by just 1,000, to 240,000—still near a multi-decade low.
  • Orders for durable goods (aircraft, machinery, computer equipment, and other big-ticket items) climbed 1.7% in February, while January’s total was revised higher. Business investment dipped for the first time five months, as orders for core capital goods fell 0.1%.

Back page: Don’t look small—look tiny

In contrast to underperforming small-cap stocks, an “undersized” segment of the real estate market has been gathering some steam. Tiny houses, loosely defined as those taking up 400 or fewer square feet of space, have been popping up across the country, with California, Oregon, Texas, North Carolina, and Florida the top five destinations. (There’s even a reality TV show, “Tiny House Nation.”) 


Retirees and young professionals have shown the most interest in exploring this housing option. Both groups have been drawn to tiny homes’ lower cost of around $25,000. Their environmentally friendly features, including the need for fewer raw materials to build and less energy to heat and cool, also fit in well with millennials’ lifestyle. While it’s still too early to tell whether growth in this niche segment will end up making a meaningful contribution to new home sales overall, it’s a trend worth watching.

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