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A brief dose of volatility hurts U.S. equities

Brian Nick, Chief Investment Strategist, TIAA Investments

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May 19, 2017

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Quote of the week

“I like to think of myself as an oilman. As an oilman, I hope that you'll forgive just good old-fashioned plain speaking.”—Daniel Plainvew, from the movie “There Will be Blood.”


The Lead Story: Black gold, Texas tease

Traders often cite rising oil prices as a key component of equity rallies. On May 15, for example, the S&P 500 Index hit a fresh all-time high as oil prices jumped, thanks to pledges by Russia and Saudi Arabia to cut output. However, history tells us that oil and equities don’t mix—or at least they don’t usually move in the same direction. That’s partly because the Energy sector has represented a small slice of the S&P 500 (just 7%, on average, since 1986). Oil prices primarily reflect supply and demand for petroleum-based products; stock market performance is based on corporate earnings, valuations, investor sentiment, and interest rates, among other variables. And for most companies, higher oil prices translate to higher input costs and lower profits.

Brian Nick, Chief Investment Strategist, TIAA Investments

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There have been occasions, though, when the two have moved in tandem, particularly during times of sharply rising or falling demand for oil. In an example of the former, the West Texas Intermediate benchmark rose 70% from April 2009 to April 2010, reflecting the global economy’s improved state. Concurrently, the S&P 500 began to recover from its crisis lows, surging 54%. And in the latter case, U.S. equities and crude declined 13% and 45%, respectively, from their November 2015 peaks to February 2016 troughs, amid concerns that a slowdown in China—with potentially negative consequences for growth worldwide—would hurt demand for oil. 


Over the past year or so, stocks and oil have gone their separate ways, a trend we expect to continue. We also believe coordinated supply cuts from OPEC and non-OPEC producers, along with decreasing U.S. inventories and stronger global demand, will push crude prices higher over the balance of 2017. This should help extend Energy’s earnings recovery, allowing the sector to rebound from its disappointing start to the year (-10.2% vs. 6.5% for the S&P 500 as of May 18).

In other news: Political uncertainty weighs on equity markets

A sitting president denies allegations of wrongdoing. There are rumblings about impeachment. Stocks and the currency tumble. Events in the U.S.? Well, yes—more about that later—but here I’m referring to allegations that Brazilian President Michel Temer authorized “hush money” to buy the silence of a witness in a corruption scandal. Brazil's stock market, the Bovespa, plunged more than 10% immediately after opening on May 18, halting trading. Brazil’s currency, the real, plummeted 7% against the dollar. Both stocks and the real rose sharply the next day.   


In the U.S., mounting political turmoil in Washington—specifically the new claims that President Donald Trump attempted to interfere in an FBI investigation into former national security adviser Michael Flynn —heightened concerns that the administration has lost the political capital needed to push through its pro-business agenda. In response, on May 17 the dollar slid to a six-month low, and the S&P 500 lost 1.8%, its worst day in eight months and the first time since March 21 that the index has fallen by 1% or more in a single trading day. The index rebounded after the midweek stumble, offsetting most of the decline.

Thanks to the dollar’s weakening versus the euro, Europe’s STOXX 600 Index fared far better, rising 1.4% for the week (in U.S. dollars).   


In U.S. fixed-income markets, demand for safe-haven assets supported a Treasury rally. The yield on the bellwether 10-year note, which moves inversely to its price, fell 11 basis points (0.11%) to 2.22% on May 17 before closing the week at 2.24%. Returns for non-Treasury sectors were broadly positive, with investment-grade corporate bonds outperforming. Year-to-date through May 18, the asset class has returned over 3%, aided by consistent fund flows.

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

Below the fold: The U.S. economy appears to be accelerating

In a mostly positive week for U.S. data releases, we’re seeing evidence of better second-quarter GDP growth, which we expect to hit 3.0%-3.5%, up from the first quarter’s 0.7% gain. Among the reports:

  • The Conference Board’s index of leading economic indicators rose for the fourth consecutive month in April, suggesting that the economy will rebound after a disappointing first quarter.
  • U.S. industrial output, a measure of output at factories, mines and utilities, jumped in April to its fastest pace in more than three years. Capacity utilization, which measures the extent to which businesses use their production potential, hit a 20-month high. Taken together, these two reports point to a pickup in capital expenditures in the second half of the year.
  • Homebuilder confidence rebounded in May, with the NAHB/Wells Fargo index hovering near March’s 12-year high. However, housing starts and building permits, a forward-looking indicator, both fell in April.

In the Eurozone, the mood remains notably upbeat:

  • Economic sentiment soared in May, according to the closely watched ZEW survey.
  • Consistent with the region’s improved outlook, inflation expectations have also been rising. Final readings for April show that prices increased 1.9%—welcome news for the European Central Bank as it aims to maintain inflation rates below, but close to, 2% over the medium term.
  • Germany’s economic mood brightened, too, confirming that the currency bloc’s largest economy is in good shape.

Back page: OPEC, no longer prime at the pump

The announcement that the Saudis and Russians had agreed to extend oil output curbs of 1.8 million barrels per day (m/b/d) drew some comparisons to OPEC’s cutting of 2 m/b/d to the U.S. during the 1973/74 oil embargo. However, the only real parallel is in the sheer number of barrels removed from the market. In 1973, OPEC accounted for about 65% of U.S. crude oil imports. The reduction sent prices in the U.S. soaring, from $3.00 per barrel (p/b) to $12p/b in six months. 


While OPEC may have had the U.S. over a barrel, the crisis deepened the U.S.’ resolve to achieve energy self-sufficiency, initiated with then-Secretary of State Henry Kissinger’s “Project Independence,” unveiled during the heat of the crisis. Since then, the U.S. has successfully pursued a path toward energy independence, while technology has led to a proliferation of energy sources both in and outside of the U.S. 

The U.S. still imports 40% of its oil from OPEC, which maintains  a 42% market share of global supply. As we approach next week’s OPEC policy meeting, expect the extension of output cuts to buoy prices, but the effect of any curb will be a mere drop in the bucket compared to its impact back in 1973.

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