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A brief dose of volatility hurts the S&P 500

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November 17, 2017

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Quote of the week

“It first marched left and then marched right, then marched under a chair/And when I looked where it had gone, it wasn't even there.”– Tom Paxton, from “The Marvelous Little Toy”

The Lead Story: A nifty streak ends at 50

After treading water for the first two days of the week, the S&P 500 Index fell 0.53% on November 15, its first daily drop of more than 0.5%, or 50 basis points, in 50 trading sessions.  Markets fretted about a wide range of issues, including uncertainty around U.S. tax reform and cracks in the high-yield bond market. (Falling high-yield bond prices often track equity market weakness.)

But on November 16, the S&P 500 jumped 0.8%—its best single-day return since September 11—as the House passed its tax overhaul plan and several key companies announced encouraging third-quarter earnings results. The “risk-on” mood proved to be short-lived, though. U.S. equities stumbled the following day, ending the week with a 0.1% loss.

Brian Nick - 140px

Brian Nick, Chief Investment Strategist, TIAA Investments

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Europe’s STOXX 600 followed a similar path, snapping a seven-day skid on November 16 before fading on Friday. For the week, European equities lost 1.3% in local terms. A stronger euro, fueled by consensus-topping German GDP data, hurt shares of exporters, exacerbating the decline.

In other news: High-yield corporate bonds struggle, and the Treasury curve flattens further

Pressure in fixed-income markets was concentrated mostly in high-yield (HY) bonds, whose prices fell for five consecutive days beginning on November 9, generating a raft of anxious headlines. Weak corporate earnings releases from HY issuers, concerns over the prospects for tax reform, and a flattening yield curve had investors rethinking their risk appetites. 

According to Lipper, HY mutual fund and exchange-traded fund outflows totaled $4.4 billion for the week ending November 15, among the largest one-week withdrawals on record. For the month through November 16, HY has lost 0.82%, an unusual occurrence for an asset class that has generated positive returns in 18 out of the past 21 months, based on the Bloomberg Barclays U.S. High-Yield index.
   
We’re a bit more sanguine on HY’s near- and intermediate-term outlook. First, losses have been restricted to a few sectors, namely Telecommunications, Cable, and Utilities. Second, a U.S. economic recession is unlikely in the next 12-15 months, reducing the possibility of a spike in HY default rates and thus a potentially prolonged market selloff. Finally, reduced HY issuance in the coming weeks should help stabilize HY prices. All that being said, if oil hits another rough patch, or volatility in equity markets increases, we could see more instability in HY markets.

Meanwhile, the U.S. Treasury yield curve continued to flatten. With the yield on the 2-year security rising in line with expectations for further Fed rate hikes, and the bellwether 10-year note dipping to 2.33% on November 15, the yield gap shrunk to 70 basis points (0.70%) midweek, a 10-year low. (The 10-year Treasury ended the week at 2.35%.) Such a convergence often spawns anxiety because a flattening yield curve can be viewed as a harbinger of a recession.

But that might not be the case today. In addition to our confidence in the U.S. economy’s health, we believe the shape of the yield curve has been distorted by years of Federal Reserve quantitative easing and the ongoing monetary support provided by other central banks. Further flattening is possible, though, if the Fed continues to raise rates systematically and wage growth fails to materialize, putting downward pressure on longer-dated yields.

Below the fold: Inflation fails to heat up in an otherwise solid week for U.S. economic data releases

With gasoline prices slipping in the wake of their hurricane-related spike, the Consumer Price Index (CPI) edged up by just 0.1% in October. Over the prior 12 months, headline CPI has risen 2.0%. “Core” inflation, which excludes food and energy costs, rose 0.2% in October and 1.8% versus a year ago. Though inflation was tame, retail sales topped expectations in October. (See “The Back Page” for further details.)

Meanwhile, so-called “soft” economic data—reports based on sentiment surveys—continued to strengthen. According to the NFIB index, small business optimism increased in October, extending its string of historically high readings that began after last November’s presidential election. More business owners expect a pickup in sales and believe now is a good time to expand. On the employment front, the tight labor market seemed to have tightened further. More than half (59%) of those surveyed indicated that they had tried to hire last month, with 88% reporting no or few qualified applicants.

Homebuilder confidence also improved in October, with the NAHB/Wells Fargo index hitting an eight-month peak and its second-highest level since 2005. Buoyed by solid job and economic growth, along with low mortgage rates, the housing market is poised to remain on steady ground heading into 2018. October’s data on housing starts (+13.7%) and building permits (+5.9%) confirmed that view, as they jumped to their highest levels in 12 and nine months, respectively. Disruptions caused by the September hurricanes faded, and communities in Texas and Florida began to replace homes damaged by flooding.

The Back Page: Retail registers are ringing in the pre-holiday season

Given the persistent negative headlines heralding the death of brick-and-mortar retail stores, I’m often surprised to see such an establishment teeming with shoppers. Yet that was the case when I walked into a Brooklyn, N.Y., mall two weekends before “Black Friday” sales hysteria kicks in.

My visit gave me hope that October’s retail sales data might surprise to the upside. Sure enough, sales rose by a better-than-expected 0.2%, lifting their year-over-year gain to a solid 4.7%. Moreover, September’s robust reading of 1.6%, which reflected post-hurricane spending, was revised higher, to 1.9%. Sales of bigger-ticket items such as furniture, electronics, and automobiles were especially good in October. However, sales at gardening and building materials stores, which accelerated in the storms’ immediate aftermath, declined sharply.

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