10.27.17

Global equities get a lift from the ECB and strong U.S. GDP

Brian Nick

Article Highlights

Quote of the week

“The most important single ingredient in the formula of success is knowing how to get along well with people.” ― Theodore Roosevelt

The Lead Story: Another quarter of 3% U.S. GDP growth
 

According to the government’s advance estimate released on October 27, the U.S. economy expanded at a 3.0% annual rate in the third quarter—ahead of most forecasts but just below its 3.1% second-quarter pace. The U.S. economy has now registered 3% growth in back-to-back quarters for the first time since 2014. Personal consumption expenditures (the economy’s main driver) increased at a 2.4% annualized rate despite the hurricane-related damage to Florida and Texas. Exports (+2.8%) also added meaningfully, as did nonresidential fixed investment (+1.8%), a proxy for business spending. On a less positive note, both disposable personal income and final sales to domestic purchasers grew by far less than the headline number. (The latter measures goods and services produced in the U.S. and purchased by U.S. consumers and businesses.)

Although details of the report provided few upside surprises, the GDP components that we want to see improving at this later stage of the economic cycle are doing so. Therefore, we’re raising our growth forecast for 2017 as a whole to 2.4%, up from 2.2%. Meanwhile, we believe the Federal Reserve remains on track to hike rates in December despite an only tepid 1.3% increase in the “core” PCE index, the Fed’s preferred inflation gauge.

Other key economic data releases for the week also outstripped forecasts.
  • Orders for durable goods (e.g., aircraft, machinery, computer equipment, and other big-ticket items), leaped 2.2% in September. Core capital goods, a key measure of business investment, rose 1.3% in September and 7.8% over the past year, its quickest annual rate since 2012.
  • New home sales soared 18.9% in September, their fastest pace in 10 years. This is welcome news for the housing market, which has fought a number of headwinds, including a lack of homes available for sale, a shortage of skilled construction labor, and the late-summer storms.

Buoyed by the GDP report, the S&P 500 Index erased earlier declines to gain 0.2% for the week, its seventh consecutive one-week advance. In U.S. fixed-income markets, the yield on the 10-year Treasury rose to 2.46% on October 26, its highest level since March 17. (Yield and price move in opposite directions.) However, risk appetite abated on October 27, as reports indicated that the Catalan parliament had voted for a resolution to declare independence from Spain, fueling demand for safe-haven assets. In response, the 10-year yield fell to close the week at 2.42%.

Returns for non-Treasury fixed-income sectors were broadly negative for the week through October 26. Among corporate debt, lower-rated high-yield bonds have performed especially well this year. In our view, this segment is most vulnerable to a pullback or correction.

In other news: The ECB unveils the first stage of its exit strategy
 

With Fed watching focused mainly on who President Trump will pick to replace Janet Yellen as chair, markets turned their attention to the October 26 meeting of the European Central Bank (ECB). Rather than announcing an end to quantitative easing (QE) as some hawks had hoped, ECB President Mario Draghi stated that the ECB will extend its purchases of government and corporate bonds, currently a total of €60 billion/month, through year-end.

Then, beginning in January 2018, the ECB will halve its QE bond buying, to €30 billion/month, and continue at that level until at least September 2018. Draghi also made clear that the ECB will not raise interest rates “for an extended period of time, and well past the horizon of our net asset purchases,” while still reinvesting the maturing principal payments of its bond holdings. Draghi’s confidence in the Eurozone’s economic recovery was tempered by his highlighting the region’s stubbornly low rate of inflation, which continues to fall short of the ECB’s target of just under 2%.

This playbook is virtually identical to the Fed’s in December 2013, when then-chair Ben Bernanke communicated its taper program. The Fed ended its asset purchase program in October 2014 as scheduled but did not raise rates for another year or so. Moreover, it continued to reinvest all maturing proceeds of its balance-sheet positions for three years after the end of the program.

Although the announcement was closely in line with expectations, markets perceived the ECB’s “lower-for-longer” approach as dovish, pushing down the euro from $1.183 on October 26 to as low as $1.157 the next day. European equity markets cheered the likelihood of further accommodative monetary policy. The STOXX 600 Index rose 0.9% for the week (in local currency terms).

Below the fold: Congress takes the next step toward tax reform
 

On October 26, the House of Representatives followed the Senate by narrowly passing a budget resolution, further paving the way for tax reform. This resolution is especially important for Republicans because it will allow them, as the majority party, to pass tax legislation without any Democratic votes. The House is also preparing to introduce a bill into the Ways and Means committee, which, among other things, will provide details of proposed tax cuts and methods of generating revenue. 

One revenue raiser being discussed is scaling back the limit for pre-tax 401(k) contributions. In our view, a bill including this provision is unlikely to become law. First, capping 401(k) plans is highly unpopular. Second, while limiting 401(k) contributions may be an effective way to generate income for the U.S. Treasury—and would be more progressive than the current law, which disproportionately benefits high-income earners—Democrats are unlikely to support such a proposal if it helps fund reduced rates for corporations or high income earners. Without any Democrats on board, the Republicans’ margin for error becomes even thinner.
 

The Back Page: U.S. exports should benefit amid improved global manufacturing
 

According to the Purchasing Managers Index (PMI) index published by Markit, U.S. manufacturing activity climbed to 54.5 in October, its best reading since January. (Readings above 50 indicate expansion.)

Manufacturing worldwide is mirroring U.S. strength. Markit’s global PMI for September hit 53.2—the highest level since the company began tracking data in 2011. This upturn has triggered the fastest pace of hiring in six years, as employers in all but three of the 40 countries tracked (China, Brazil, and South Korea) have increased staff. 

Contrary to the previous business cycle, manufacturing has favored developed markets (DM) over emerging markets (EM). In DM, along with a strong showing by the U.S. Japan experienced solid growth last month (52.5), and Eurozone activity reached a 6½-year high (58.6). In EM, bellwether China has seen manufacturing expand modestly during most of 2017. Meanwhile, after a brutal two-year recession, Brazil has shown renewed vigor, with PMI readings above 50 for the first time since January 2015. 

The global manufacturing boom has been sparked by rising, broad-based consumption, which should ultimately boost U.S. GDP. Between 2013 and 2016, U.S. consumers kept the global economy afloat by purchasing international goods and services. Now, in 2017, the rest of the world has started to catch up, and global growth is more balanced across regions. The weaker dollar has helped U.S. exports, as we saw in the Q3 GDP report, but global—not
just American—manufacturers are benefiting from the synchronized cyclical upturn.
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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