Good news for the U.S. economy makes for a bad week in the financial markets

Brian Nick, Chief Investment Strategist, TIAA Investments

The last week’s market highlights:

Supported by stellar U.S. economic data, particularly a spike in service-sector activity, yields on longer-dated Treasuries surged to multi-year highs last week, sending their prices tumbling. At the same time, continued expectations for gradual Federal Reserve tightening limited the increase in yields on shorter-maturity securities. As a result, the Treasury yield curve steepened sharply.
Rising yields are often accompanied by broad equity rallies, but that didn’t happen last week. The S&P 500 began Q4 by falling 1.0% for the full week, suffering its worst one-day showing since June on October 4. But not all S&P 500 sectors sputtered. Financials, which tend to benefit from a jump in yields, rallied. So did Energy, lifted by an uptick in oil prices. Value stocks easily outpaced growth shares—a relatively rare occurrence in a year that so far has seen value lag in 27 out of 40 weeks, or 68% of the time.
Europe’s STOXX 600 Index underperformed the U.S. in both local (-1.8%) and dollar terms (-2.6%). Eurozone economic data disappointed, with Markit’s Composite PMI falling to a four-month low amid declining exports.
Last week’s U.S. equity-market decline wasn’t fueled by trade tensions or weakening growth—quite the opposite, in fact. Similar to how higher yields caused a rough patch for the S&P 500 in February, the most recent rise reflects solid-to-strong economic growth. Indeed, in Q1 we forecast a 10-year Treasury yield in the 3%-3.25% range. It just took a bit longer than we anticipated to get there. Meanwhile, U.S. stocks have delivered handsomely, returning more than 9% YTD.
As always, we think investors are well advised to “tune out” short-term market volatility, stay diversified, and focus on their long-term financial goals.

Quote of the week:

“There's been so many things that's held us down
But now it looks like things are finally comin' around.
I know we've got a long, long way to go
And where we'll end up, I don't know.” – “Ain’t no stoppin’ us now,” McFadden & Whitehead

Each week, we present our featured topics in the context of the major themes listed below from the Nuveen Q4 Outlook:

U.S. economy: Still running ahead of its peers.
Global economy: Trade a bigger concern outside the U.S.
Policy watch: Trade risks haven’t bitten the U.S. yet, but that may change.
Fixed income: Continue to position for rising rates.
Equities: The price is right outside the U.S.
Asset allocation: Finding pockets of opportunity.

Fixed income: Bond bears are feeling vindicated

Like a child afraid of its shadow, the 10-year U.S. Treasury yield has approached—or briefly crossed—the psychologically significant 3% threshold at various points throughout the year, only to retreat.

After starting the year at 2.40%, the 10-year climbed to 2.94% on February 21, reflecting the bond market’s improving assessment of U.S. economic growth and concerns about rising inflation. But a number of factors halted that ascent, including trade-war fears and cooling inflation expectations.

In mid May, a steady stream of solid economic data releases propelled the 10-year yield to 3.11%. That increase was short lived, too. Geopolitical uncertainty in the wake of President Trump’s decision to pull out of talks with North Korea, along with ongoing concerns around U.S./China trade policy, stoked demand for safe-haven assets such as longer-dated Treasuries. Against this backdrop, the 10-year rallied, its yield falling to 2.77% on May 29. (Bond yields and prices move in opposite directions.)

Last week, the 10-year acted as if it were afraid no more. It jumped 10 basis points (0.10%) on October 3 alone and 18 basis points for the week as a whole, closing at 3.23% on October 5—its highest level since May 2011.

So what happened? For starters, strong U.S. economic data releases:

The U.S. service sector, which accounts for about 80% of the U.S. economy, sizzled in September, as measured by the non-manufacturing index published by the Institute for Supply Management (ISM). This index surged to a 21-year peak of 61.6. (Readings above 50 indicate expansion). Employers in service industries stepped up hiring at a record pace, and new orders rose sharply.

U.S. factories continued to hum, albeit at a slightly slower pace, with ISM’s manufacturing gauge hitting 59.8. The employment sub-index rose, suggesting robust growth in factory hiring, as did new export orders, indicating a pick-up in global demand.

The ADP employment release, typically published two days before the Labor Department’s monthly payrolls report, was especially good. It’s viewed as a barometer of private-sector hiring.

Other factors behind last week’s bond market volatility included reduced foreign purchases of Treasuries amid rising hedging costs and a deal between the U.S. and Canada to revise NAFTA. The agreement improved investor risk appetite, trimming demand for Treasuries.

U.S. economy: Just like December ’69

Despite some disruptions on the East Coast attributed to Hurricane Florence, the U.S. economy added 134,000 jobs in September. Payrolls for July and August were revised upward by a combined 87,000, bringing the monthly average for the third quarter to 190,000—still a strong result. Job growth, on average, reached an even-better 201,000/month over the past 12 months. The unemployment rate fell to 3.7%, its lowest level since late 1969. Moreover, the number of unemployed workers dropped below 6 million for the first time since 2000.

One downside in the report was a bigger gap between the headline unemployment rate (3.7%) and the underemployment rate (7.5%), which includes workers who don’t have a full-time job or one that reflects their training/educational background. This suggests there may still be some spare capacity (or “slack”) left in the labor force and may explain why average hourly earnings (AHE) haven’t accelerated meaningfully this year. AHE increased 2.8% over the past 12 months, continuing a streak of sub-3% year-over-year growth that began in 2009.

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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