Investors regain their footing after last Monday’s meltdown

Brian Nick

The last week’s market highlights:

Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2021 Midyear Outlook :
  • U.S. economy: The growth rate has peaked but will remain high throughout 2021.
  • Global economy: The economic recovery will spread to Europe and eventually Asia as more countries achieve herd immunity from COVID-19.
  • Policy watch: Policy is becoming marginally less accommodative as the recovery takes hold.
  • Fixed income: Even with rates subdued, credit-sensitive parts of the market should lead.
  • Equities: The best opportunities may now lie outside the U.S.
  • Asset allocation: Continue to allocate toward assets poised to benefit from economic reopening and recovery from the pandemic.

Quote of the week:

"Each of us has a fire in our hearts for something. It’s our goal in life to find it and keep it.”  – Mary Lou Retton

Growth scare was sharp but short

Markets abhor a vacuum. When one appears, it tends to be filled quickly. Take last Monday, July 19, for example. Without major economic data releases to react to or speeches by Federal Reserve officials to parse, investors decided to accentuate the negative. The S&P 500 Index fell 1.6% that day, seemingly because of increasing concerns about the COVID-19 Delta variant and its potential impact on growth (more on Delta in the next section). These worries came on top of news the day before that OPEC and other major oil exporters planned to boost production — an announcement that spooked the energy sector, in particular, as increased supply would likely counter rising oil prices.
While the impact of the “growth scare” was pronounced, it was mercifully short-lived. The S&P 500 more than offset last Monday’s loss by rallying over the next four days.
That’s not to say the equity market’s jitters were entirely unfounded. Slowing growth, because of the Delta variant or some other cause, in the context of high valuations for U.S. stocks, warrant caution. But we think valuations have room to fall as earnings growth continues to “backfill” the gains over the past year, when investors were often willing to pay steep prices for companies in expectation of far higher profits ahead. In other words, earnings growth is now catching up with the rise in prices, effectively lowering the price-to-earnings ratio. The chances of a sharp, sustained drop in valuations owing to a genuine economic slowdown seem remote for now. In our view, any decline in valuations will almost certainly be gentler than their rapid climb last year.
Turning to fixed income markets, until last Monday investors had been focused on fears of decelerating growth, driven by perceptions of an overly hawkish Fed that might begin withdrawing its ultra-easy policy prematurely. But with new worries emanating last week from an entirely different source — the Delta variant — bond markets actually priced out a considerable amount of Fed tightening, as measured by the fed funds rate futures market. (Fed funds futures are used by traders to place bets on the path of interest rates.)
More importantly, unlike the swift rebound in the stock market following last Monday’s drop, the dovish turn in fed funds futures has held. The Fed’s leaders (with an assist from worrisome virus headlines) have seized back the accommodative policy megaphone after leaving the outcome of their June meeting open to misinterpretation. At that gathering, Chair Jerome Powell and his colleagues faced the dilemma of whether to maintain extremely easy policy until the unemployment rate fell further from its then-level of 5.8%, or begin to tighten policy to keep inflation in check.3
So what’s our view on growth? Our midyear outlook, “Growth is peaking. What comes next?,” spells it out. We expect growth to slow from here in economies such as the U.S. that have already experienced their reopening “boom.” But we are convinced that consumers will grab the baton from policymakers (and vaccine developers) as the primary driver of the decelerating but still solid economic expansion. As their balance sheets make clear, consumers have amassed unprecedented savings and seen their net worth and incomes grow while their liabilities have become easier to cover.

Delta variant likely to complicate but not derail the global recovery

While falling vaccination rates have been making headlines recently and case counts are on the rise even in highly vaccinated areas, we don’t expect this latest wave of the pandemic to produce a significant economic pullback. This is especially true in the U.S., which continues to reopen strongly judging by the (admittedly imperfect) data on individual mobility such as driving, walking and public transportation.
The U.S. has been culturally “resistant” (for lack of a better term) to the pandemic’s economic impact compared to close peers such as the U.K and the eurozone. In our view, there are two explanations for this phenomenon.
  1. U.S. government restrictions have been less onerous and have gone in only one direction — more relaxed — since the spring of 2020. That’s why the U.S. economic downturn ended well over a year ago, while many other countries have endured a double-dip recession (a sequence of recession, brief recovery, and then another recession).
  2. Consumers adapted to the pandemic differently in the U.S. than in other places. For example, personal mobility did not decline as much even as the most severe wave hit at the end of 2020, and it began to increase almost as soon as vaccines became available, even before the average weekly death toll had peaked. This was not the pattern in virtually any other nation. The governments of France and the U.K. imposed stricter lockdowns last fall and were slower to remove them.
As we see it, the bottom line for investors worried about the impact of another COVID-19 wave in the U.S. is this: the virus on its own can’t shut down the economy. Only state and local governments (by reimposing draconian lockdown measures) and consumers (by choosing to avoid travel, dining out and going to sporting events, to name a few activities) can. And with vaccines widely available in most of the world’s largest economies, the incentives for elected officials to put those restrictions back in place have dropped significantly. Consumers, meanwhile, seem happy to go back to reliving their pre-pandemic lives, likely because they feel safe…regardless of whether they’re vaccinated or not.
Here's the caveat, though. What we just described certainly applies to the U.S., but it’s less clear how the economies of other countries with lower vaccination rates or populations that are less averse to lockdowns will react to another wave of infections. If the Delta variant disrupts Europe’s or Asia’s comebacks, then our midyear outlook calling for a smooth, sequenced global economic reopening may not come to pass. If, however, the U.S. remains the “surest” bet for robust consumer demand and corporate earnings growth, recent dollar strength could prove enduring rather than transitory, solidifying better performance from U.S. financial assets relative to the rest of the world.
  1. MarketWatch, FactSet
  2. MarketWatch
  3. BLS via Haver
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, sell or hold a security or investment strategy, 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 financial professionals. 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.