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U.S. stocks benefit from “addition by subtraction”

Brian Nick, Chief Investment Strategist, TIAA Investments


August 25, 2017

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Quote of the week

“Wild honey smells of freedom/The dust, of sunlight/The mouth of a young girl, like a violet/But gold smells of nothing.”– Russian poet Anna Akhmatova

The Lead Story: What’s behind this year’s gold rush?

Gold bugs are out in force. The precious metal has gained 10.9% year to date through August 24, edging out the 10.4% advance of the S&P 500 Index. Long perceived as a safe-haven asset, gold has historically rallied when geopolitical or financial uncertainty has rattled markets, or during periods of declining interest rates. (Falling rates lessen the appeal of risk-free assets such as Treasuries.)

This year, though, the price of gold stayed relatively flat in the wake of the terrorist attacks in Europe and didn’t spike dramatically amid tensions between the U.S. and North Korea, as investors kept their composure in both instances. Instead, gold has been supported by a combination of low interest rates—the yield on the 10-year U.S. Treasury note has ranged between 2.20% and 2.50% for most of 2017—and a patient Federal Reserve.

Brian Nick, Chief Investment Strategist, TIAA Investments

Brian Nick - 140px

Article Highlights

Looking ahead, the potential for a contentious debt-ceiling debate in the fall could increase gold’s attractiveness. In contrast, gold might lose some of its luster following the European Central Bank’s eventual exit from its quantitative easing program, which will likely lead to higher Eurozone sovereign bond yields and, in turn, higher U.S. Treasury yields.

In our view, gold is generally not the most effective asset to own in a long-term portfolio, at least not in the form of a “real” metal. Despite its reputation as an inflation hedge, gold on its own does not pay any dividend (as many stocks do), interest (as bonds do), or rental income (as real estate does). This lack of annual return means that gold may not be able to keep up with inflation over time, reducing its potential utility and suitability for this purpose. Moreover, gold’s fair value is exceedingly difficult to assess. Even after losing a cumulative 30% over the past five years, it’s not clear whether gold is currently undervalued. 

That’s not to say that some gold exposure can’t add to a portfolio’s performance in some cases. But we think the benefits are more likely to come from owning an equity or bond of a fundamentally sound gold-related issuer—a mining company with operational strengths and an attractive valuation, for example—than from holding the metal itself.

In other news: U.S. stocks end a positive week on a positive note

Amid typically sluggish late-summer trading, the S&P 500 gained 0.7% for the week. With the harsh rhetoric between Washington and Pyongyang easing, the S&P 500 Index rose 1% on August 22, more than offsetting modest losses on the following two days. Stocks got a late-week “fiscal-policy boost” as the Trump administration began to outline plans for individual tax reform. However, a speech by Federal Reserve Chair Janet Yellen at the Fed’s annual symposium in Jackson Hole, Wyoming, failed to move markets or provide any meaningful monetary policy clues.

Across the Atlantic, the Eurozone’s manufacturing and service sectors maintained momentum in August. Markit’s “flash” (preliminary) Purchasing Managers’ Index registered 55.8, well above the 50 mark separating expansion from contraction and marginally ahead of July’s reading. Despite this strong report, Europe’s STOXX 600 Index fell 0.1% for the week in local currency terms.

In U.S. bond markets, the yield on the 10-year Treasury note closed at 2.17% on August 25, slightly below where it began the week. (Yield and price move in opposite directions.) Returns for non-Treasury sectors were positive for the week through August 24. High-yield bonds (+0.23%) outperformed, shrugging off outflows. As we head into the historically volatile fall season, we have reduced our fixed-income portfolios’ exposure to the riskiest credit categories while remaining broadly diversified.

Below the fold: Signs of stress in the housing market

On the heels of July’s decline in building permits and housing starts, new home sales slid 9.4% in July to their lowest level in seven months and were down 8.9% versus a year ago. Meanwhile, existing home sales fell 1.3% to their slowest pace in 2017, but stayed 2.1% higher compared to last year. 

Orders for durable goods (e.g., aircraft, machinery, computer equipment, and other big-ticket items) also slumped in July, registering their biggest one-month fall (6.8%) in three years. The drop was mostly due to a plunge in the volatile civilian aircraft category. On an encouraging  note, core capital goods, a key measure of business investment, rose 0.4%.

The Back Page: Looking for a great place to live? Look “down under.”

With housing data figuring prominently over the past few weeks, we were curious to read the Economist Intelligence Unit’s 2017 “Global Livability Report.” This annual survey ranks 140 of the world’s major cities on stability, health care, culture and entertainment, education, and infrastructure. The most desirable “urban centers” tend to be mid-sized and located in wealthy countries; larger cities often have higher crime rates and stretched infrastructure. 

Melbourne, Australia, took the top slot for a record seventh year in a row, followed closely by Vienna, Austria. Rounding out the top 10 were three Canadian cities (Vancouver, Toronto, and Calgary), two more from Australia (Adelaide and Perth) and Europe (Helsinki and Hamburg), and Auckland, New Zealand. Sadly, terrorism has become a quality-of-life concern for a number of cities in the Middle East and Africa. Damascus, Lagos, and Tripoli were considered the three worst places to live.  
As one might expect, Melbourne’s well-earned fame has made it a costly place to shop for a home. Over the past year or so, house prices have jumped 17%, so buying a nice place there will “cost big bikkies.” Locals, though, might argue that it’s “bloody” well worth it.