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U.S. equities overcome serial concerns

Brian Nick, Chief Investment Strategist, TIAA Investments


April 21, 2017

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Quote of the week

"The suspense is terrible. I hope it will last.” – Oscar Wilde

The Lead Story: Snap, crackle, pop

Why do Rice Krispies make those familiar sounds? Scientists have discovered that when milk is poured onto the cereal, it flows into the crispy kernels, puts pressure on the air inside, and fractures the kernel walls.

Year-to-date through April 20, financial markets have left a mostly good taste in our mouth, as all major asset classes are in positive territory. But how will investors hold up amid the “snap, crackle, and pop” outlined below?

SNAP: British Prime Minister Theresa May stunned the political world by calling for a “snap” (early and previously unscheduled) election on June 8. May, who replaced David Cameron after the Brexit vote, had previously dismissed the idea of an early election

Brian Nick, Chief Investment Strategist, TIAA Investments

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Article Highlights

Why the U-turn? May’s Conservative Party holds only a slim majority in Parliament. However, current polling suggests that with the opposition Labour Party’s support at a multi-decade low, and with the wind taken out of the populist Independence Party’s sails, May could gain more seats. The British pound rose amid expectations that she will do exactly that, giving her greater flexibility and standing to negotiate during the UK’s split from the European Union.

CRACKLE: That’s the sound of the ground beginning to shift below investors’ feet. Although ongoing tensions in North Korea and Syria haven’t dissipated, much of the past week’s angst emanated from France. An apparent April 20 terrorist attack in Paris, while tragic, will probably not alter the outcome of the first round of the French Presidential election on April 23. Polls and oddsmakers alike show center-left candidate Emmanuel Macron likely to qualify for the May 7 runoff. Macron would be heavily favored in a head-to-head contest with either the Nationalist stalwart, Marine Le Pen, or the socialist insurgent, Jean Luc Melenchon. But were the race to come down to a Le Pen vs. Melenchon matchup, the near-term impact would likely be negative for French equities and bonds, and for global markets as a whole.

Despite this political backdrop, European bond markets were little changed during the past week. The spread between yields on 10-year French and German government bonds narrowed  slightly, implying that election jitters may have eased somewhat.  (The spread tends to widen during periods of heightened market uncertainty.)

Meanwhile, in U.S. fixed-income markets, an unwelcome combination of factors drove the bellwether 10-year Treasury yield down to 2.18% on April 19, marking a five-month low. In addition to the geopolitical and European election concerns, diminished expectations for near-term fiscal and tax stimulus, weaker U.S. manufacturing output, and growing evidence of reluctant consumers put investors on the defensive. The 10-year closed the week at 2.22%.

For the week through April 20, returns for most non-Treasury fixed-income “spread sectors” were slightly negative. High-yield bonds, which tend to be more highly correlated to equity markets, eked out a small gain.

POP: As in, “pop” goes the Trump reflation trade. U.S. interest rates and the U.S. dollar have pulled  back amid political uncertainty, including the looming prospect of a government shutdown. In addition, while the U.S. equity market is still within sight of all-time highs, the mix of sector leadership has rotated from cyclicals to defensives this month. Although Treasury Secretary Steve Mnuchin indicated on April 20 that the Trump administration is close to unveiling major tax reform—and on April 21 President Trump himself promised an announcement on taxes next week—Democrats have already vowed to oppose any such bill until the president reveals his tax returns, something he has steadfastly refused to do. Moreover, details around a renewed effort on health care reform are still sketchy.

We remain confident that even in the absence of a policy boost from Washington, the U.S. economy is well-positioned to grow above trend over the balance of 2017. Additional tightening from the Fed should also contribute to a “re-reflation” of longer-term interest rates.

In other news: U.S. stocks outpace Europe

After slipping the prior two weeks, the S&P 500 shrugged off negative overseas headlines and mixed economic data, rising about 0.8% for the week, aided by Mnuchin’s and Trump’s hopeful words on tax reform. Europe’s STOXX 600 failed to extend the prior week’s gain, finishing down 0.07% in U.S. dollar terms.

In terms of first-quarter earnings, just under 20% of S&P 500 companies have reported. So far, evidence seems to support consensus expectations of stronger year-over-year profits growth compared to 2016. Earnings are coming in close to 5% better than expected, according to Bloomberg, while full-year estimates for 2017 and 2018 are approaching 10% annual growth. Despite early positive reports from Financials stocks, the sector has been struggling in April, largely due to sharply falling U.S. interest rates. We will be closely watching results from Energy companies, whose stocks have badly trailed the broader market this year.

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

Below the fold: There’s a surprise party going on outside the U.S.

Economic data in the Eurozone and across emerging-market (EM) countries continues to exceed expectations, as reflected by the respective Citi Economic Surprise indexes. (The index gauges the extent to which economic data releases diverge from consensus forecasts; rising index levels indicate more upside surprises.)

For example, growth in the Eurozone’s manufacturing and service sectors hit a six-year high in April, according to the “flash” preliminary reading of Markit’s Purchasing Managers’ Index. Germany and France, the region’s two largest economies, kept humming along, and the pace of expansion elsewhere in the currency bloc accelerated to a near 10-year high.

The story has been far less positive in the U.S. The Citi Economic Surprise Index, which started to fall in March following a strong post-election pickup, plunged during the past week. Meanwhile, U.S. consumers have yet to put their money where their mouth is, even as they remain hopeful about the economy’s direction. Among the week’s reports:

The Back Page: Sometimes you have to go against the grain

Like many successful businessmen, W.K. Kellogg, whose company developed Rice Krispies (and many other breakfast foods), was a bit of contrarian. As many businesses cut advertising costs during the Great Depression, Kellogg doubled his budget for ads, and profits soared. Kellogg's also began sponsoring radio shows for children, introducing cartoon elves—called “Snap,” “Crackle,” and “Pop”—to sell Rice Krispies, which hit the market in 1928. (A fourth elf, “Pow,” briefly appeared in 1950.)

It’s impossible to tell how Mr. Kellogg would have invested in today’s uncertain markets, although he once stated that “Dollars have never been known to produce character, and character will never be produced by money. I’ll invest my money in people.”