November 10, 2017
“What’s the difference between a taxidermist and a tax collector? The taxidermist takes only your skin.” ― Mark Twain
After advancing for eight consecutive weeks, most recently on expectations for business-friendly tax relief, U.S. equities fell about 0.2% for the week. Driving this decline was news that Senate Republicans were considering a tax-reform bill that diverges from the House proposal. In particular, the Senate’s version delays corporate tax cuts until 2019 rather than implementing them next year. Amid this uncertainty, investors rotated out of cyclical shares such as financials and into stocks offering quality growth potential, especially those of technology companies.
However, markets continued to get a lift from solid (high single-digit) third-quarter corporate revenue/earnings growth. According to FactSet, with 81% of S&P 500 companies having reported through November 3, 74% have delivered positive earnings-per-share surprises, and 66% have registered better-than-expected sales results. In our view, investors will eventually turn their attention away from the short-term “noise” in Washington, refocusing instead on steadily improving corporate profits.
Brian Nick, Chief Investment Strategist, TIAA Investments
Outside the U.S., Europe’s STOXX 600 Index suffered its worst one-week fall (1.9% in local terms) in three months, as lackluster earnings deflated optimism over encouraging Eurozone economic data.
This sour mood did not extend to Japan, though. Before retreating on November 9 and 10, the Nikkei 225 Index hit a 25-year high, bolstered by an 18% surge (in yen terms) over the past two months. A number of factors have fueled this advance. These include:
These tailwinds notwithstanding, we expect the Nikkei’s rally to fade. Investor capital should ultimately find a home in select markets within Europe or the developing world, both of which offer more attractive equity valuations and better growth potential.
Amid the threat of inflation and a near-certain Federal Reserve rate hike next month, yields on longer-dated U.S. government bonds rose as the week concluded. For example, after remaining rangebound for most of the week, the yield on the bellwether 10-year note jumped by seven basis points (0.07%) on November 10 alone to close at 2.40%. (Bond yield and price move in opposite directions.) Intensifying this dynamic is the recent start of the Fed’s gradual unwinding of its massive balance sheet.
Non-Treasury markets also struggled. For the week ending November 9, high-yield (HY) corporate bonds (-0.75% total return) were hit by outflows as some of the largest HY bond issuers produced lackluster quarterly results. Technical factors hurt investment-grade corporate bonds (-0.22% total return), which faltered as companies rushed to issue debt before any tax changes kick in.
A few sectors bucked this negative trend. Commercial mortgage-backed and asset-backed securities, for example, posted small gains—illustrating the importance of building a diversified portfolio.
Despite the week’s downturn in certain asset classes and pickup in volatility, we doubt a significant market adjustment is imminent. Inflation risks are modest, and near- and intermediate-term recession risks still muted. Additionally, incoming Fed Chair Jerome Powell is likely to continue the Fed’s gradual, data-dependent shift to higher rates. More significant selloffs, should they occur, could provide buying opportunities.
The Eurozone’s manufacturing and service sectors began the fourth quarter on a high note. Markit’s final Purchasing Managers’ Index for October registered 56, well above the 50 mark separating expansion from contraction and among the highest readings over the past 6½ years. Business optimism stayed elevated, as companies benefited from surging domestic demand and expectations for ongoing strong business and consumer spending. Also, the rate of job creation reached a multi-year high.
Not surprisingly, then, the European Commission raised its 2017 Eurozone real GDP growth rate from 1.7% to 2.2%—the region’s fastest pace in a decade.
Meanwhile, U.S. labor markets kept up their positive momentum on the heels of October’s healthy payrolls data. Job openings rose to 6.1 million in September, according to the Labor Department’s JOLTS report. Openings have been at or near record-high levels since June. And although first-time unemployment claims increased by a more-than-expected 10,000, to 239,000, the less volatile four-week moving average fell by 1,250, to 231,250, a 44-year low.
These effects, however, are differentiated among specific markets and may be tempered for a variety of reasons:
Against this backdrop, we believe the U.S. dollar’s recent rally has not diminished EMD’s attractiveness as an asset class. EMD continues to be supported by a synchronized global economic expansion and modest inflationary pressures—especially wage growth—which have allowed central banks to gradually normalize policy. And for yield-starved investors, real EM rates look compelling relative to the negative real rates in many developed countries.
Bonds and other fixed-income investments are subject to various risks including interest rate risk. Investments in emerging market bonds involve higher risk. Investments in debt securities issued or guaranteed by governments or governmental entities are subject to the risk that an entity may delay or refuse to pay interest or principal on its sovereign debt because of cash flow problems, insufficient foreign reserves, or political or other considerations. In this event, there may be no legal process for collecting sovereign debts that a governmental entity has not repaid.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of TIAA Global Asset Management, its affiliates, or other TIAA Global Asset Management staff. These views are presented for informational purposes only and may change in response to changing economic and market conditions. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor's objectives and circumstances and in consultation with his or her advisors. Certain products and services may not be available to all entities or persons. Past performance is not indicative of future results. Economic and market forecasts are subject to uncertainty and may change based on varying market conditions, political and economic developments.
Nuveen, LLC, formerly known as TIAA Global Asset Management, delivers the expertise of TIAA Investments and its independent investment affiliates.
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