Good times, bad times, investors have their share

Brian Nick, Chief Investment Strategist, TIAA Investments

The last week’s market highlights:

U.S. equities might have been feeling a bit fatigued last week from following the seemingly non-stop flow of U.S.-China trade headlines. Although President Donald Trump delayed his March 1 deadline for raising tariffs on $200 billion of Chinese goods—a favorable outcome from the market’s perspective—the S&P 500 Index struggled to eke out a small gain. Investors likely aren’t tired of the stock market’s 2019 performance, though. The index rose 3.1% in February, bringing its year-to-date gain to a stellar 11.8%.

Europe’s STOXX 600 Index (+0.8% for the week in local currency terms, +1.1% in U.S. dollar terms) outperformed. Because the eurozone’s open economy stands to benefit significantly from a resolution to global trade tensions, good news on that front is almost always good news for shareholders. The outcome was mixed in terms of economic data, however. According to Markit, eurozone manufacturing activity contracted in February for the first time since June 2013, with Germany and Italy the biggest culprits. On the bright side, the region’s unemployment rate fell in December to 7.8%, its lowest level since 2008, while inflation edged up in February.

With U.S. economic growth slowing to 2.6% in the fourth quarter, some market watchers have suggested that the Federal Reserve was right to pause and turn dovish in January. We disagree. As recently as September, the Fed had forecast 2.3% growth and 2.0% inflation in 2019—a forecast that still looks on track despite nine rate increases since 2015 and a steady reduction of the Fed’s balance sheet. In our view, the Fed’s apparent decision to take March and June hikes off the table through its more dovish rhetoric was an unnecessary policy change. Looking ahead, we think officials will survey the damage from the U.S. government shutdown, which could be substantial, and wait for a second-quarter rebound. If one occurs, a September rate hike is in play.

For weeks, the yield on the bellwether 10-year U.S. Treasury note lingered between 2.60% and 2.70%, as investors were plagued by concerns over a dire outlook for the U.S. economy and hand-wringing from the Fed about subdued inflation expectations. Those expectations appear to have been unfounded, given the 1.9% December reading for the core PCE Index, the Fed’s preferred inflation barometer. The 10-year yield closed at a five-week high of 2.76% on March 1, up 11 basis points (0.11%) for the week. A number of factors likely contributed to the increase: the surprisingly sturdy GDP print, Fed Chair Jerome Powell’s “un-dovish” Congressional testimony and February’s bounceback in consumer confidence, as reported by The Conference Board.

Quote of the week:

“Vanity working on a weak head produces every sort of mischief.” – Jane Austen (Emma)

Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2019 Outlook :

U.S. economy: A slowdown, not a recession
Global economy: Amid lower expectations, emerging markets could surprise to the upside
Policy watch: Fewer tailwinds, stronger headwinds
Fixed income: Rates likelier to rise than fall
Equities: Late cycle but good value
Asset allocation: A neutral stock-bond view

U.S. economy: That wasn’t so bad

Thanks to the government shutdown, the advance estimate of fourth-quarter GDP was released on February 28, four weeks later than scheduled. The economy grew at a 2.6% annualized pace, far slower than it did in the second (4.2%) and third quarter (3.4%), but at a faster clip than consensus forecasts of approximately 2.3%. And looking under the hood of the economy’s engine, the underlying details were stronger than the headline number suggests:

Personal consumption rose 2.8% (annualized), a sign that consumers were in a shopping frame of mind.
Non-residential fixed investment growth (6.2%) rebounded from a weak third quarter.
Within that category, business spending on intellectual property was the standout, growing at a 13.1% annualized rate.

Inventory changes also provided a slight lift, which is consistent with the quarter’s healthy job gains. After all, employers wouldn’t have added an average of 232,000 payrolls per month in the fourth quarter if they weren’t planning to restock their shelves.

On the down side, trade was a fourth-quarter drag, albeit a small one. Imports (+2.7%) outpaced exports (+1.6%), which lagged due to the U.S.-China standoff, a weaker global economy and a stronger dollar. Residential investment (-3.5%) likewise took a small bite out of GDP. Higher mortgage rates and home prices have hurt the still-struggling housing sector. Last week, we learned that housing starts plunged in December to a two-year low. But in a sign that better times may lie ahead, building permits rose for the month of December and on a year-over-year basis. Permits are considered a leading indicator of the health of the housing market.

With the books closed on 2018 GDP (pending the final estimate later this month), one key question is: Did the U.S. economy grow at the psychologically important 3% annual rate? That depends on how one views the data. The answer could be “yes,” given the 3.1% year-over-year fourth-quarter gain. But the answer could also be “no,” based on the economy’s 2.9% pace over the full calendar year 2018 versus calendar year 2017.

One year from now, we don’t expect to be having a similar discussion. Hitting a “three-handle” GDP growth rate in 2019 will be exceedingly difficult for a single quarter, much less the full year. First-quarter data is already pointing to a slowing economy. On Friday, for example, the Institute for Supply Management reported that its manufacturing PMI had eased in February to 54.2, a two-year low. Amid the fading effects of last year’s fiscal stimulus and the Fed not likely to cut rates anytime soon, we’re looking for 2% to 2.5% growth this year. That’s not so bad, but it’s a notable slowdown from 2018.

China’s economy: That wasn’t so good

Chinese economic data is showing only tentative signs of bottoming. According to China’s National Bureau of Statistics (NBS), manufacturing activity declined for the third month in a row in February, with the NBS Purchasing Managers’ Index (PMI) falling to 49.2, a three-year low. (Readings under 50 indicate contraction.) The exports and employment subindexes both dropped sharply. One encouraging sign: New orders, a leading indicator, moved back above the 50 mark.

February’s downbeat PMI release comes hard on the heels of news that in 2018, the Chinese economy expanded at its slowest pace since 1990. For its part, the government isn’t sitting still. Indeed, it has adopted a series of stimulus measures to help lift economic growth:

Issued bonds to finance new infrastructure. Local governments flooded the market with these securities and offered inducements to spur demand from banks.
Cut taxes. To increase domestic consumption and confidence among businesses, who for years have complained about growing tax burdens, Chinese lawmakers rolled out a series of tax breaks and incentives.
Eased monetary policy. The People’s Bank of China (PBoC) injected cash into the banking system and has repeatedly cut the share of deposits that banks must hold on reserve at the PBoC, thus freeing up money for investment and lending.

Evidence is emerging that these measures may be having an impact. Credit growth is on the upswing, in particular among cash-starved smaller firms. On the consumer side, online retail sales have skyrocketed, and home prices have edged up. More help could be on the way in the wake of President Donald Trump’s decision to extend the March 1 deadline for raising tariffs on $200 billion of Chinese goods.

An even bigger economic boost may come from Beijing’s plan to ease its crackdown on shadow banking, the unregulated segment of China’s financial sector. Shadow banking assets—a wide range of high-yielding, “off-balance-sheet” investment products marketed by banks, insurance companies and wealth management firms—jumped to around $10 trillion last year. In response, the government issued stiff regulations to curb the industry’s rise. But amid China’s economic deceleration, policy officials began to have second thoughts. Although they’re well aware of the need to scale back the country’s mountain of debt, they also know that these risky loans keep the economy well lubricated.

Equity investors haven’t waited for the economy to rebound fully. China’s Shanghai Composite Index rose 7% last week (+20% year to date), officially entering bull market territory. (A bull market is defined as a rally of at least 20% from its most recent trough.) Markets were stoked by optimism over the U.S.-China trade talks and news that MSCI will increase exposure to Chinese stocks in its flagship emerging markets benchmark index. Such a move, slated to take effect in November, could bring as much as $125 billion into Chinese shares, according to some estimates. With inflation low and its currency (the renminbi, or yuan) holding up reasonably well, China is unlikely to hit the stimulus brakes any time soon. That could mean more fuel for this sharp rally.

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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