Global equities get a late-week lift courtesy of the U.S. job market

Brian Nick

Article Highlights

Quote of the week

Peggy Sue: “You just keep thinking ‘high tech.’”
Richard: “‛High tech?’ That’s nice.”– From “Peggy Sue Got Married”

The Lead Story: A “we’ve seen this before” jobs report

November’s employment report seems to repeat what we’ve seen many times over the past few years: strong job creation but soft wage growth. The U.S. economy cranked out a better-than-expected 228,000 payrolls, while the unemployment rate remained at a 17-year low of 4.1%. The labor-force participation rate (62.7%) also held steady. Unfortunately, growth in average hourly earnings (AHE) rose only 2.5% year-over-year, below forecasts for 2.7%, and October’s initial 2.4% figure was revised downward, to 2.3%. At some point, wages will rise more quickly, which could prompt the Fed to tighten more aggressively. For now, though, we believe policymakers have the option to raise rates gradually, with three hikes in 2018 as a baseline unless the Fed tells us otherwise when it meets next week.

While we view a hike in the federal funds rate on December 13 as a done deal, the Fed’s puzzle about what to do with interest rates next year remains. Some measures of wage growth other than AHE are showing healthier gains, and that may influence the Fed to raise rates in March 2018 instead of waiting longer. The market seems to agree with this sentiment: fed funds futures, which on December 7 implied a 63% chance of a Fed rate hike at the March 2018 meeting, didn’t budge after the release of the jobs report.

Also on December 13, markets will take particular notice of the Fed’s post-meeting statement, looking for clues as to policymakers’ economic outlook for 2018 and their expectations on the path and scope of future rate hikes.

In fixed-income markets, the yields on both 2- and 10-year Treasuries were little changed during the week, closing at 1.79% and 2.38%, respectively, on December 8. This left the yield curve close to its flattest point in a decade.

Returns for non-Treasury sectors were mixed for the week ending December 7. We expect demand for these “spread” sectors to remain robust, reflecting the likelihood of tax reform passage, the prospects for ongoing equity market strength, and, importantly, only remote U.S. recession risks in the next 12-18 months amid solid global growth, especially from Europe.

In other news: U.S. investors can thank the dollar

For the year to date through December 7, Europe’s STOXX 600 Index has returned a relatively modest 7.7% in local terms despite a backdrop of better-than-expected corporate earnings and economic growth on the continent. To illustrate the latter point, the Citigroup Eurozone Surprise Index, which broadly measures whether economic data has topped or lagged forecasts, recently hit a seven-year peak even as expectations for Eurozone GDP have been revised higher throughout the year.

Internationally diversified U.S. investors should still be pleased with the performance of their   overseas holdings. Thanks to the dollar’s steep fall versus the euro in 2017, the STOXX 600 has delivered a stellar 20.1% gain in dollar terms (versus 18.3% for the S&P 500 Index). Moreover, with the pace of European corporate earnings growth (in percentage terms) exceeding local-market equity returns this year, Eurozone shares are more attractively priced today compared to U.S. stocks than they were in January. In our view, this provides opportunities for investors to “have their cake” in 2017 and “eat it, too,” in 2018. For the week, the STOXX 600 gained 1.38% in dollar terms but just 0.1% in local terms, thanks to the resurgent dollar.
In the U.S., the S&P 500 snapped a four-day losing streak on December 7 and moved higher in the wake of November’s solid jobs report to return 0.4% for the week. Although Technology stocks endured another volatile week, we wouldn’t be surprised to see them push higher into year-end, as they have often rallied in December. We think tech shares can build on their 38% year-to-date gain in 2018, given the sector’s array of highly “disruptive” companies such as those developing electric vehicles, advancing digital advertising, and reshaping e-commerce.

At the same time, we’re mindful that tech may succumb to profit taking, as investors close the books on what should be a banner year. Additionally, if Congress passes a tax bill that triggers faster GDP growth, we believe economically sensitive cyclical stocks, such as Industrials and Materials, will outperform. Tech could also lag behind more heavily taxed sectors such as Financials, which would benefit substantially from proposals to cut corporate taxes.

Below the fold: The U.S. service sector remains robust while consumers turn a bit cautious

With investors anxiously awaiting November’s jobs report, this week’s light data calendar did little to move markets. Among the reports:

  • U.S. non-manufacturing activity, as measured by the ISM index, slipped to 57.4 in November from October’s 12-year high of 60.1 but stayed comfortably above the 50 level separating expansion from contraction.
  • Consumer sentiment eased, according to December’s preliminary reading of the University of Michigan index. Although consumers are still upbeat about current economic conditions, they expressed some concern about the impact of proposed tax reforms.
  • Fueled by a surge in imports, the trade deficit jumped 8.9%, to a nine-month high of $48.7 billion, from $44.9 billion in September.


The Back Page: Economic benefit from individual rate cuts likely to be short-lived

Although significant differences need to be reconciled in conference committee between the House and Senate tax proposals, the final bill will undoubtedly trim existing marginal rates. But will lower taxes lead to greater consumer spending?

To get an idea, we examined the effects of tax cuts signed into law by President George W. Bush in June 2001. Not only did the bill reduce marginal rates, but later that summer the government began mailing rebate checks of up to $600 to all taxpayers who filed a 2000 tax return. In theory, this should have lifted personal consumption.

In practice, though, the economic impact of the cuts and rebates was both nominal and short-lived. With the recession ongoing, households initially pocketed the extra income, resulting in the savings rate spiking from less than 4% in June 2001 to 6.3% by September. Personal consumption picked up briefly during the next quarter, as people spent their rebate checks, but not in a way that added sustained growth potential to the economy. (For example, they didn’t use the money to refurbish a factory.) GDP growth went from -1.3% in Q3 2001 to +3.7% by Q1 2002, but the growth rate tailed off again after the checks were spent.

Both the Joint Committee on Taxation and private estimates suggest the current bill under consideration—in its final form—will lift GDP growth by an average of 0.1% a year for the next 10 years. Most of this gain will be front-loaded to 2018 and 2019, thanks in part to the effects of tax write-offs for business investment. In the end, this round of individual tax cuts, like its 2001 predecessor, could yield only modest—and temporary—results.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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