U.S. equities not in festive mood as the holiday season approaches         

Brian Nick

The last week’s market highlights:

Quote of the week:

“I’m drawn to almost any piece of writing with the words ‘divine love’ and ‘impeachment’ in the first sentence.” – Anne Lamott   
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 4Q 2019 Outlook :
  • U.S. economy: Still seeing signs of growth
  • Global economy: Downward pressure but no recession.    
  • Policy watch: Markets expect more easing  
  • Fixed income: Opt for high quality, longer maturity  
  • Equities: Get defensive, stay invested  
  • Asset allocation: While cautious, still prefer emerging-market bonds    

Equities/Fixed Income: I can’t get it for you wholesale 

This week brings Thanksgiving and “Black Friday.” Folks searching for bargains will begin lining up outside malls well before sunrise. If history’s any guide, many will successfully find deals.
The same can’t be said for investors, who would be hard pressed to find any publicly traded assets “on sale.” To illustrate:
  • U.S. stocks look expensive. In 2019, the price/earnings (P/E) ratio of the S&P 500 Index has risen from 14.3X earnings to 17.5X earnings, compared to an average of 14.8X since 2006.4 Investors must now pay far more for a dollar of expected earnings than they did 11 months ago.
  • So do non-U.S. stocks. In overseas equity markets, the P/E ratio of Europe’s STOXX 600 Index sits at 14.6X, up from 12.1X in January and above its average of 12.8X. Emerging markets equities (P/E of 12.2X as of November 22) are also not cheap.5   
  • Bond yields are compensating less for risk. The difference (or “spread”) between yields on U.S. Treasury securities and investment-grade corporate bonds has narrowed by 44 basis points during the year.6 That means corporate bond investors are now receiving less income for assuming credit risk than at the start of the year.      
Although P/E ratios and yields are poor predictors of near-term performance, they tend to serve as reliable gauges of longer-term results. In our view, today’s relatively high valuations and low payouts suggest subdued returns over the next five to ten years for stocks and corporate bonds, respectively, compared to the past decade. 
But if investors are concerned about this unfavorable outlook, they’re not showing it. Demand for corporate bonds remains healthy amid the global search for income. On the equity front, the VIX, or Wall Street “fear gauge,” recently fell to 12.1, near its lowest level of the year and far below its 25-year average of 19.6.7 Lastly, according to the Financial Times, hedge funds have placed a record number of bets (via “shorting” the VIX) that this tranquil backdrop will persist.
Equity investors’ optimism can be seen in the stellar returns of technology stocks (+42.6% for the year to date), by far the best-performing S&P 500 sector.8 Tech is on pace for its strongest year in a decade, fueled by demand for companies with the potential to deliver healthy earnings despite a slowing economy.
Growth stocks overall have long been the equity market’s darlings, outpacing their value counterparts by a wide margin over the prior three-, five- and 10-year periods.9 (While growth stocks often carry high P/Es based on their ability to deliver high earnings, value shares tend to trade at lower P/Es on hopes they’ll rally once the broader market recognizes their full potential.) But value stocks have made something of a comeback. They’ve outpaced growth substantially over the past three months, putting them in the lead for 2019 as a whole.

A weaker fourth quarter for the U.S. economy? Maybe, maybe not. 

After generating 3.1% GDP growth (annualized) in the first quarter of 2019, the U.S. economy has slowed dramatically, to 2.0% and 1.9% in the second and third quarters, respectively.10 Will that trend persist as the year winds down? Two closely watched GDP trackers, the Atlanta Fed’s “GDP Now” and the New York Fed’s “Nowcast,” seem to think so. They’re predicting fourth-quarter growth in the 0.4%-0.7% range, which would mark the weakest three-month period for the U.S. since 2015.
But it’s important not to put too much stock in these forecasts—not yet, anyway. We’re still early in the fourth quarter’s economic data calendar, even if December is right around the corner. October releases are just starting to trickle in. Meanwhile, both of the GDP tracker models assume that consumer spending and residential construction will continue to slow. That may not turn out to be true. In fact, last week’s data releases included evidence of better economic activity that could potentially auger a more favorable year-end growth outlook:    
  • Housing data was strong. Low mortgage rates and rising personal incomes have brought buyers off the sidelines. Housing starts rebounded in October, and building permits, a forward-looking indicator, surged to a 12-year peak. Moreover, homebuilder sentiment proved resilient in November as optimism for sales in the next six months hit its highest mark since May 2018. 11
  • Markit’s “flash” (preliminary) Composite Purchasing Managers’ Index registered 51.9 in November, a 4-month high. (Readings above 50 indicate expansion.) Manufacturing and service-sector activity strengthened on the back of improved inflows of new business. Encouragingly, firms added to payrolls, primarily to handle rising backlogs of work.
On the down side, The Conference Board’s index of leading economic indicators declined for the third straight month in October, and its six-month growth rate turned negative for the first time since May 2016.
Given the mix of both encouraging and lackluster readings, the strength of the economy’s fourth-quarter growth remains a question mark. That uncertainty will end in late January, when the government releases its advance GDP estimate for the quarter.   
  1. S&P 500 data from Haver
  2. Bloomberg
  3. Nuveen, Marketwatch
  4. Bloomberg
  5. Bloomberg
  6. Bloomberg
  7. Haver
  8. FactSet, Wall Street Journal
  9. Bloomberg
  10. Haver
  11. RenMac
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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