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Global equities are mixed as Tech shares stumble

Brian Nick, Chief Investment Strategist, TIAA Investments


July 28, 2017

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Quote of the week

“Better to remain silent and be thought a fool than to speak and to remove all doubt.” Various

The Lead Story: A good U.S. GDP report

According to the government’s advance estimate, the U.S. economy expanded at a 2.6% annual rate in the second quarter, just above our 2.5% forecast. Personal consumption expenditures (which make up the bulk of GDP) improved significantly since the first quarter, and business investment remained strong. Net export gains and government spending both contributed modestly. In contrast, spending on homebuilding and improvements was especially weak. 

Given the stronger showing by consumers and businesses, we are maintaining our 18-month GDP growth forecast at 2.5%—about 0.5% above the economy’s long-term potential. In our view, this pace is achievable even without fiscal stimulus. U.S. export growth has improved  since global growth bottomed in the first quarter of 2016; a weaker dollar should help make U.S. products even more competitive in overseas markets, further strengthening the domestic economy.

Brian Nick, Chief Investment Strategist, TIAA Investments

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Article Highlights

What happens if the economy achieves 2.5% GDP growth through 2018? In theory, a lower unemployment rate, higher wages, and hotter inflation. In theory.

In other news: The Fed tweaks and markets speak

On July 26, the Federal Reserve voted unanimously to maintain the federal funds target rate at 1%-1.25%, a foregone conclusion, according to markets. Language indicating that the Fed would implement its balance-sheet reduction plan “relatively soon” scarcely raised an eyebrow, but markets seized on a few tweaks to the Fed’s June policy statement that made it slightly more dovish, in our view. These include the Fed’s description of inflation as running “below” target rather than “somewhat below.” And in a nod to the economy’s prolonged period of sluggish price gains, the Fed omitted referring to declines in inflation as “recent.”

Markets interpreted the Fed’s inflation assessment as flat-out dovish. In response, the dollar fell to a 13-month low against a basket of currencies and a 2½-year low ($1.17) versus the euro. The yield on the bellwether 10-year Treasury note dropped before heading gently higher to close the week at 2.30%. (Yield and price move in opposite directions.)  

In non-Treasury markets, high-yield bonds delivered a positive, albeit modest, return (+0.2%) for the week through July 27, supported by a two-month high in oil prices. Despite inflows, particularly from Europe and Asia, investment-grade corporates (-0.5%) lagged.

Looking ahead, we believe inflation will strengthen sufficiently for the Fed to hike once more this year, most likely in December, although we wouldn’t be shocked if the move is put off until 2018.  As we see it, officials are in no hurry to remove policy accommodation. 

Also on our radar is the slope of the yield curve. The spread between 3-month and 10-year Treasuries reached as low as 105 basis points (1.05%) on July 25, down from 194 basis points on January 1. A narrower spread reflects the bond market’s subdued view of growth and inflation. In addition, the pace of the Fed’s balance-sheet reduction program, coupled with Fed guidance, could significantly affect both the Treasury and mortgage-backed security markets.

Global equity performance was mixed, with the Information Technology sector weighing on results.  The S&P 500 Index finished essentially flat. Europe’s STOXX 600 Index slipped 0.5% in local terms, but the dollar’s slide versus the euro reversed that loss to a 0.2% gain.

Below the fold: Homebuyers face a double whammy

According to the National Association of Realtors, housing inventory has been falling steadily for more than two years. Housing prices, though, have been rising, as evidenced by May’s 5.7% year-over-year gain in the S&P/Case Shiller 20-City Composite Index. Against this challenging backdrop, existing home sales fell by a more-than-expected 1.8% in June. 

Among the week’s other key releases:

  • Defying expectations for a slight dip, consumer confidence jumped in July to its second-highest level since December 2000, according to The Conference Board. Consumers cited strength in the labor and equity markets as reasons for their upbeat mood. However, consumer sentiment, as measured by the final reading of the University of Michigan index, hit a nine-month low.
  • After two months of declines, durable goods orders soared 6.5% in June, to a three-year high. Most of the gain, though, was due to a surge in civilian aircraft orders. Aside from strong demand for planes, orders increased just 0.2%. Moreover, core capital goods, a key measure of business investment, fell 0.1% in June, its first decrease this year.

Back page: The global economy remains on track

Buttressed by solid growth in emerging markets (EM), global GDP is expected to grow an estimated 3.5% in 2017 and 3.6% in 2018, up from 3.2% last year, according to the World Economic Outlook published on July 23 by the International Monetary Fund (IMF).

In developed markets (DM), the IMF expects that GDP expansion of 2% in 2017 will slip to 1.9% next year. Reduced expectations in both the U.S. (2.1% GDP growth in 2017 and 2018) and the U.K. were partially offset by the IMF’s improved forecast for the Eurozone, Canada, and to a lesser degree, Japan. Europe is poised for a stronger, more sustained economic rebound, while political risks have eased since earlier this year. In particular, Italy and Spain, the Eurozone’s third- and fourth-largest economies, respectively, have improved faster than anticipated.

The IMF expects EM GDP growth of 4.6% in 2017 to accelerate to 4.8% in 2018, bolstered by China’s continued fiscal stimulus. The world’s second-largest economy is forecast to expand at a rate of 6.7% and 6.4% in 2017 and 2018, respectively. India, one of the world’s fastest-growing economies, should do even better—7.2% and 7.7%, respectively.

The IMF cites short-term risks as somewhat balanced but notes heightened medium-term concerns over geopolitics and trade.

All told, the IMF’s outlook reinforces our view of a healthy global economy, now led by a broader collection of countries, including those in the Eurozone and EM, in addition to the U.S. The relatively tepid outlook in DM is driven by headwinds from aging populations, weak investment, and slowly increasing productivity.