Key Points

• The equity rally faded as investors began focusing on rising bond yields and the climbing U.S. dollar.
• The political backdrop still appears to promote economic growth, but investors are focusing more on specific policies.
• Equity leadership has shifted noticeably as markets become more dynamic.

U.S. equities finished mostly lower last week, with the S&P 500 Index down 0.9%.1 Rising interest rates and the climbing U.S. dollar weighed on sentiment, and investors started turning from broad hopes of fiscal stimulus and tax reform to wondering about specifics. And oil prices rallied strongly due to OPEC’s agreement to enact production cuts.


Weekly Top Themes

1. The November payrolls report confirmed that the job market is healing. The numbers were broadly in line with expectations. The unemployment rate fell more than expected to 4.6%, mainly due to a drop in the participation rate.2 Average hourly earnings fell for the first time since last December by 0.1% following a strong 0.4% gain in October.2

2. The manufacturing sector is gaining momentum, as previous headwinds such as lower oil prices have faded. The Institute for Supply Management Manufacturing Survey came in ahead of expectations, while the Output Index reached its highest level in 20 months.3

3. Consumer and business confidence have advanced since the election. This has boosted short-term U.S. economic activity. However, the potential downside includes an increase in mortgage rates and upward pressure on the dollar. Additionally, the political backdrop could cause a jolt to confidence levels if attention turns back to anti-globalization efforts.

4. Treasury yields should experience ongoing upward pressure, but the pace is likely to slow. We expect yields will rise unevenly over the next few years as the economy continues to accelerate and as inflation moves higher, but market action should be more orderly than recent activity.

5. Corporate earnings-per-share growth is accelerating. In November, 6 of the 11 S&P 500 sectors showed upward EPS revisions.4 The overall percentage of upward revisions was 60%, the highest level in several years.4

Market Rotation Is the Real Equity Story

U.S. equity markets appear dominated by two opposing trends. On the positive side, anticipation over possible tax reforms, fiscal stimulus and infrastructure spending, as well as improving investor confidence, are pushing prices higher. Conversely, higher bond yields and the rising dollar are causing concern since these developments could potentially slow economic growth before the positive factors kick in next year.

For most of November, the positive forces won, but concerns are rising that stock prices have run too far, too fast. Additionally, the post-election market environment is shifting as investors are focusing on specific policy questions. There remains a broad sense that President-elect Trump and the GOP Congress will focus on progrowth initiatives. Investors appear reassured by Trump’s mostly traditional political appointees, but the initial euphoria has faded. Investors are looking for specifics about tax reform policies, whether corporate and individual tax reform efforts will be combined and how spending priorities will be sequenced. At the same time, concerns appear to be growing that Donald Trump may be returning to the more combative anti-immigration and
anti-globalization rhetoric that dominated his campaign.

To us, the big story within equities is not the intense rally, but the significant rotation in market leadership. Financials (and banks in particular) have soared, while capital goods-related companies also experienced gains.1 Health care stocks rallied immediately after the election, but that rally stalled as investors await specific policy proposals.1 On the other hand, income-oriented and bond proxy sectors have lagged significantly.1 We also see intra-sector dispersions. In technology, undervalued, domestically-oriented segments have done quite well, while traditional growth and more globally-focused companies have lagged.1

In general, we think most of these trends will persist into early 2017, but market leadership is becoming more dynamic. This suggests that investment selectivity is growing in importance, an implicit argument for active management.

Bob Doll is chief equity strategist at Nuveen Asset Management.

1 Source: Morningstar Direct, as of 12/2/16
2 Source: Bureau of Labor Statistics
3 Source: Institute of Supply Management and Markit
4 Source: Citi Research