Key Points
• The Fed will likely raise interest rates in December, although policy should remain accommodative.
• Government bond yields will likely remain low despite mounting evidence of improving growth. This should benefit equities.
• Equities may be expensive compared to their own history, but they appear attractive compared to bonds and cash.
U.S. equities rallied again last week, with the S&P 500 Index climbing 1.2%.1 Investor sentiment improved due to generally dovish tones from the Federal Reserve and Bank of Japan. Real estate and utilities led the week’s rally, while energy lagged despite an increase in oil prices.1
Weekly Top Themes
1. The Fed signaled a likely rate hike in December. To no one’s surprise, the Fed did not raise rates at its meeting last week. But it clearly indicated that a hike is coming soon, provided economic growth remains on track and the global financial system does not endure an additional shock. The Fed statement included this new, unambiguous statement: “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”
2. U.S. inflation is slowly creeping higher. The core Consumer Price Index climbed 0.3% in August and is up 2.3% year-over-year.2
2017 economic growth may look similar to 2016. At the beginning of the year, we expected U.S. growth to remain slow but avoid a recession. At this point, we expect to see a similar environment next year, but we think it is possible we may see even slower levels of growth.
3. U.S. equities appear more attractive than international stocks. Compared to overseas alternatives, we believe the U.S. market features better economic growth, stronger earnings trends and more supportive monetary policy. If global trade levels increase, our view would be more constructive toward non-U.S. equities.
4. The U.S. political environment looks to be a mixed bag for equities. At this point, Hillary Clinton seems to hold the edge in the race for the White House. Compared to Donald Trump, Clinton’s policies offer more clarity and continuity, which would be a net positive for equity markets. Nevertheless, it appears she would push for more government regulations, and both candidates have adopted anti-globalization and anti-free-trade policies. That’s not great news for stocks, and given globalization has been a major deflationary force for decades, it also isn’t great news for bonds. One silver lining is that we see growing prospects for increased infrastructure spending and possible corporate tax reform.
Equities Aren’t Cheap, But Appear Relatively Attractive
Equity prices have advanced over the last few weeks, as central banks signaled they will continue to promote growth and provide liquidity. The Fed remains the only central bank pondering a rate increase, although it has signaled it will move cautiously. This backdrop is likely to suppress government bond yields despite mounting evidence of global economic growth improvements. Such an environment is supportive for risk assets.
As such, we continue to believe in a mildly pro-growth, pro-risk investment stance. We think equities will likely improve against a backdrop of record-low interest rates and modestly improving growth. When the Fed finally raises rates again (probably in December), it could jolt the markets. But even with another 25 basispoint increase, the fed funds rate would remain extremely low given the growth and inflation environment.
At the same time, we understand why many investors are cautious. The world continues to recover from the financial crisis and Great Recession, remains in deleveraging mode and navigates a wide array of geopolitical uncertainties. Compounding this backdrop, pockets of the equity market are somewhat expensive historically. Given low bond yields and meager cash returns, however, we think equities look attractive on a relative basis. And we expect equity prices to continue grinding slowly higher over the coming year.
Bob Doll is chief equity strategist at Nuveen Asset Management.