04.29.19

A U.S. hat trick: GDP, equities and the dollar score for a win

Brian Nick

The last week’s market highlights:

Quote of the week:

“And you may ask yourself, well how did I get here?” – “Once in a Lifetime,” Talking Heads
 
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2Q 2019 Outlook :
  • U.S. economy: Late cycle but no recession
  • Global economy: Slower this year than last  
  • Policy watch: A dovish turn for global central banks  
  • Fixed income: Rates likelier to rise than fall
  • Equities: Get defensive, stay invested
  • Asset allocation: Still favorable to emerging-market assets

Equities: A round trip to a fresh record high

Legendary college basketball coach John Wooden often told his players, “Don’t confuse activity with accomplishment,” highlighting the importance between merely keeping busy and getting things done. While certainly relevant to athletics, this saying could also apply to the performance of U.S. stocks over the past seven months.
 
On September 20, 2018, the S&P 500 Index reached an all-time high of 2,931, fueled by strong economic data and upbeat business and consumer sentiment. But the risk-on mood didn’t last much longer. Fears of slowing global growth, especially in the U.S. and China, combined with escalating trade tensions and the perception of an increasingly hawkish Federal Reserve, fueled steep equity declines in October and December. Only a post-Christmas surge saved the S&P 500 from entering a bear market—typically defined as a drop of 20% or more from a recent peak.
 
But the risk-off mood didn’t last much longer. U.S. equities surged in the first quarter of 2019 and have continued to rally. The S&P 500 reclaimed record territory last week, closing at 2,939 on April 26. Although this level was a mere eight points above the index’s previous all-time high, it demonstrated the ability of stocks to “get things done” this year. Here are some reasons why.
 
  • The Fed’s about face. After the Fed raised interest rates in September 2018, fed funds futures reflected a nearly 50% implied probability that officials would hike at least three more times before the end of 2019. How times have changed. Not only did the Fed not raise interest rates in the first quarter, it scaled back its previous forecasts of projected rate increases for the year to zero. And the market is now pricing in a 66% chance that the Fed might even cut rates in 2019. (Barring an exogenous shock, we think that’s unlikely to happen.)

    The result: a low-interest-rate environment that has restrained borrowing costs, boosted bottom lines and encouraged investment. It has also made bonds, the main investment alternative to stocks, far less attractive to investors searching for yield.

  • U.S./Chinese economic data heated up. The U.S. economy proved resilient as the quarter wore on, all but eliminating fears of a near-term recession. March data, for example, included multi-month highs in retail sales (+1.6%), durable goods orders (+2.7%) and core capital goods (+1.3%), a proxy for business investment. Meanwhile, the U.S. jobs engine stayed in high gear, creating 540,000 payrolls during the first quarter. In April, first-time jobless claims plumbed their lowest levels in decades.

    In China, the government’s wide range of stimulus measures seemed to be bearing fruit, evidenced by better-than-anticipated first-quarter GDP growth (+6.4%), retail sales (+8.7%) and industrial production (+8.5%).

  • U.S./Chinese economic data heated up. The U.S. economy proved resilient as the quarter wore on, all but eliminating fears of a near-term recession. March data, for example, included multi-month highs in retail sales (+1.6%), durable goods orders (+2.7%) and core capital goods (+1.3%), a proxy for business investment. Meanwhile, the U.S. jobs engine stayed in high gear, creating 540,000 payrolls during the first quarter. In April, first-time jobless claims plumbed their lowest levels in decades.

  • Risks of government dysfunction around the world shifted from “simmering” to “off the boil.” These include Brexit, which has been delayed until Halloween following the April 10 agreement between the European Union and the U.K., and the end of the U.S. government shutdown in January.

Against this backdrop, we’ll be closely monitoring corporate earnings scorecards, which we believe will largely determine the staying power of the current bull market. Even if first-quarter profit growth remains positive, as it has done so far this earnings season, we think U.S. stocks will have a tough climb given higher valuations. For example, the price-to-earnings ratio for the S&P 500 has jumped from 14.2x (next-12-months earnings) as of December 31 to 17x as of April 26—the highest since the end of February 2018.  
 

U.S. economy: Strong headline GDP number, shaky details

Here’s further evidence to quiet those who feared the U.S. Treasury yield curve’s brief inversion in late March augured a U.S. recession: According to the government’s advance estimate, released on April 26, the U.S. economy grew at a 3.2% annualized rate in the first quarter, above consensus forecasts.
While that’s a noteworthy pace of expansion, we think the underlying details of the GDP report aren’t as strong as the headline number suggests. Personal consumption, for example, increased only 1.2%, its second-weakest quarter since 2013. Private fixed investment also disappointed.
Moreover, we believe about two-thirds of the 3.2% figure can be attributed to transitory factors:
 
  • Trade uncharacteristically made the largest contribution to growth. A collapse in imports “added” more than surging exports, which were almost certainty distorted by stockpiling ahead of the U.S.-China trade dispute. (Lower levels of imports and higher levels of exports result in a greater contribution to the trade component of GDP.)
  • Inventories—things that are produced but not sold—have now added to GDP for three straight quarters but could detract in the next several quarters.
  • Government spending, entirely from the state and local level, added impressively but won’t continue indefinitely. 
That being said, there’s still room for optimism:
 
  • Final sales to private domestic purchasers, which strip out the more volatile components of GDP while preserving consumption and investment data, were likely diminished by the government shutdown and should partially bounce back in coming quarters.  
  • With unemployment still low, the personal savings rate back at 7% and business and consumer confidence high, both consumption and investment could rebound next quarter.  

All told, we think headline GDP growth will dip a bit in 2019 compared to last year but remain at a respectable—and sustainable—pace of around 2%-2.5%.
The U.S. dollar and Treasury yields fell after investors moved past the headline GDP figure and digested the full report. The yield on the bellwether 10-year note closed at 2.50% on April 26, down 7 basis points for the week.
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.
 
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.
 
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Any investment in taxable fixed-income securities is subject to certain risks, including credit risk, interest-rate risk, foreign risk, and currency risk. There are specific risks associated with international investing, which include but are not limited to foreign company risk, adverse political risk, market risk, currency risk and correlation risk. In addition, investing in securities of developing countries involve greater risk than, or in addition to, investing in developed foreign countries.
 
The investment advisory services, strategies and expertise of TIAA Investments, a division of Nuveen, are provided by Teachers Advisors, LLC and TIAA-CREF Investment Management, LLC.
 
 
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