March comes in like a (cowardly) lion for retreating equity markets

Brian Nick

The last week’s market highlights:

Quote of the week:

“If you want something said, ask a man; if you want something done, ask a woman.” – Margaret Thatcher
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. equities: Bully for the rally’s 10th birthday

On March 9, 2009, the S&P 500 Index closed at 676.53, down a head-spinning 25% for the year to date and 57% off its October 2007 peak. With analysts still slashing corporate earnings forecasts, another 25% drop seemed possible. Reflecting the market’s miserable mood, the Wall Street Journal asked “Just how low can stocks go?”
With the benefit of hindsight, the right question was, “Just how high can stocks go?”
No one could have known that the longest bull market in history was about to begin a day later. In the 10 years since that 2009 nadir, the S&P 500 has avoided falling 20% from a previous high (the technical definition of a bear market), although it came awfully close just this past December. From March 2009 through February 2019, the index generated a 16.7% average annual return, turning a hypothetical $10,000 investment into $46,000. That was the most profitable decade for U.S. stocks since the February 1991 to January 2001 period, when the S&P 500 climbed 17.4% per year on average—even with a 9% drop in 2000 amid the bursting of the tech bubble.
That brings us to a “good news/bad news” scenario. On the plus side, we don’t anticipate a bear market like the 2000-2002 downturn precipitated by the dot-com bust—at least not anytime soon. Despite February’s well-below-consensus jobs report, the economy is in good shape, and stocks are nowhere near their nosebleed valuations of the late 1990s. On the negative side, it’s highly unlikely that U.S. stocks will continue to produce the kind of outsized gains we’ve seen over the past 10 years. 
Why not? Valuations. While not useful for predicting short-term market moves, price-to-earnings (P/E) ratios have proven to be reliable forecasters of longer-term equity returns. (The higher the P/E, the lower the expected future performance, and vice versa.) 
As of March 8, the S&P 500 was valued at around 29x earnings (based on the cyclically adjusted price-to-earnings ratio, commonly known as the Shiller P/E). That figure is between the P/E lows (13x) of 2009, when stocks were poised to post average annual returns of more than 17% for a decade, and the highs (45x) of 1999-2000, when they were about to enter a “lost decade” of negligible returns. Therefore, over the next 5-10 years, we expect average annual U.S. equity returns to be somewhere in between as well—most likely in the 6% range.
Although the S&P 500 has stumbled so far in March, raining a bit on the bull market’s birthday parade, it jumped 8% in January and another 3.2% in February. That’s the best start to a year since 1991. Yet investors have been as fickle as a cat at dinner time. They yanked nearly $4 billion out of U.S. stock mutual funds and ETFs in January before wading back in last month. If global growth remains resilient and corporate earnings continue to grow, stocks could resume their rally, giving bulls more reasons to celebrate.

U.S. economy: Didn’t see that coming! (And it wasn’t so bad)  

After churning out a consensus-topping 311,000 payrolls in January, the U.S. economy appeared to slam the brakes on job creation, adding just 20,000 net new positions in February. That was well below expectations of around 175,000 and the lowest monthly total since September 2017. Looking under the headline figure, though, the employment report featured some positive news:
  • Average hourly earnings grew 3.4% year over year, their fastest pace in a decade.
  • The “underemployment” rate fell from 8.1% to 7.3%. (This rate combines unemployed workers looking for work and part-time employees seeking full-time work.)
  • Labor force participation held firm at 63.2, a 5½-year high.
Considering that the U.S. jobs engine had been firing on all cylinders in 2018 (averaging 220,000/month), investors can’t be blamed for wondering if the economy has begun to decelerate significantly. But it’s important to remember that many data releases, including monthly payrolls, are volatile. That’s why we recommend looking at 3- or 6-month averages. Over the December-February period, for example, the economy produced 186,000 jobs per month. This figure is a better indication of the underlying employment trend, in our view. We also think that future labor market reports will begin to look more like this one—with fewer jobs created and rising wages—if the U.S. is indeed at or near full employment.
Despite February’s lull, this release makes it more likely that the Fed will tighten monetary policy in the next few quarters, especially if job growth returns to a 100,000-200,000 per month pace, as we anticipate. The U.S. needs to add 80,000-120,000 new workers every month in order to keep the unemployment rate steady. When the economy is growing above its long-term trend of around 1.8%, as it did last year, monthly job creation tends to be higher, too.
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.
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