U.S. equities moved higher last week, with the S&P 500 advancing 1.40%.1 In the face of another disappointing employment report, positive recovery expectations provided tailwinds. Key manufacturing and service sector data surprised to the upside, and improved corporate confidence was highlighted by merger and acquisition activity. Developments outside the U.S. supported recovery and reform, and emerging market fears lessened. A potential U.S. military strike on Syria was an overhang as President Obama's decision to seek congressional approval raised concerns about other looming battles.
Global economy emerges from the past but is not quite ready for the future
The global economy appears to have emerged from the doldrums of 2012 and early 2013. Global GDP increased at an annualized 3% pace in the second quarter and seems on track for similar results for the third quarter.2 This reflects a move from contraction into recovery across the Euro area, alongside robust gains in the U.K. and Japan. Slightly above-trend growth in the U.S. and solid growth in developing markets is offsetting disappointing growth in emerging markets. The August Purchasing Managers' Index (PMITM) points to a constructive turn in the global manufacturing cycle. The report indicates slowing buildup of inventories and increasing growth in new orders – two developments that often precede increased industrial activity. In the near term, U.S. economic growth is on hold due to Middle East tensions, oil price spikes, Federal Reserve bond purchases, Obamacare uncertainty and regulatory overhangs.
The strong Manufacturing ISM Report on Business for August, along with near-cycle low jobless claims, suggests business conditions are firming. Acceleration for the U.S. in the second half appears probable, helped by a steepening yield curve, modest rebound in Europe and stabilization in China. Capital goods spending and industrial production should accelerate, and hopefully earnings estimates will begin to increase. Importantly, a near-term recession does not seem likely.
Current macro themes
August payrolls increased by 169,000 jobs but did not meet expectations. Also, payrolls for the previous two months were revised down. The unemployment rate declined to 7.3%, entirely accounted for by a 0.2% decline in labor force participation, equating to a new cycle low. The continued decline in the participation rate further justifies maintaining a very low federal funds rate.
The Fed does not appear to have reached consensus about tapering. July FOMC meeting minutes and recent speeches confirm this view. Our base case remains that QE tapering will begin modestly before the end of September.
A deal to fund the government and raise the debt ceiling is not imminent. Overall, we anticipate a minimal deal that may include: no tax hikes or reform, token entitlement savings, slight relaxation of the sequester, possible approval of the Keystone pipeline and a 12-month or more increase in the debt ceiling.
A congressional resolution supporting military action in Syria has a difficult and uncertain future. If the vote were held today, it would likely fail. The Administration has work to do before securing adequate support.
Debate about Syria may impact the short-term economy and markets. Subjects such as the succession of Ben Bernanke, approval of the pipeline, change to sequestration cuts, continuing resolution for government funding and immigration reform may be used to help the President attain the necessary congressional votes to pass his use of force resolution.
The big picture
The equity market remains in pause mode in the short term due to numerous uncertainties and subdued growth outlook. Over 6 to 12 months, we believe global conditions favor equities over bonds and support a moderately pro-growth investment stance. A slowly improving global economy may provide tailwinds for equities and certain risk assets, with potential headwinds for most bonds, particularly those issued by G7 governments. Risks remain for the economic outlook as markets cope with the looming shift in global monetary policy as the Fed starts tapering. There may be disruptions from the U.S. debt ceiling and announcement of the next Fed Chairman, as well as potential geopolitical tremors from the Middle East. But for now, we do not expect any of these issues to deflect the underlying trend.
Bob Doll is chief equity strategist and senior portfolio manager at Nuveen Asset Management LLC. This commentary originally appeared on the firm's website.