U.S. equities finished last week in barely negative territory, ending the positive streak for the market. Economic data concerning the post-government shutdown climate has improved. Employment data beat estimates and increased by 203,000 jobs in November, and the unemployment rate fell to 7.0%, also surpassing expectations.
DON'T FEAR THE TAPER
Economic progress should provide the Federal Reserve with the ammunition it needs to begin tapering purchases of Treasuries and other securities perhaps as soon as later this month. The Fed may still be concerned about the dip in inflation indicators, as they remain below the target level of 2%.
WEEKLY TOP THEMES
The real GDP upward revision to 3.6% for the third quarter was the fastest quarterly growth rate in almost two years. The revision did not generate much enthusiasm since it reflected a buildup of inventory. Part of the inventory accumulation was probably intended, some of it was imported, and other segments likely will be diminished once fourth-quarter reporting begins. This does not dampen our expectation of 2.5% to 3.0% real growth in 2014.
Job gains in 2013 are running slightly ahead of last year. These advances are despite a two-year contraction in nominal federal outlays for the first time in more than five decades. The labor market has improved by almost every measure since last fall.
The ISM Manufacturing Report for November ended above consensus expectations. ISM data tends to lead GDP, and over the last two quarters, the range has been consistent with more than 3.0% real GDP growth.
The University of Michigan consumer sentiment survey jumped to 82.5 for December. This is the highest level since July.
Positive chatter continues but a final budget agreement has not yet been reached in Washington. The proposed deal would provide a moderate fiscal boost next year by replacing scheduled sequester cuts with increased user fees and other savings spread over time.
THE BIG PICTURE
Macroeconomic risks have been diminishing as the global economic recovery slowly broadens and seems to be gathering momentum. The United States, the euro area, Japan and China are all expanding or accelerating simultaneously, which should make growth more durable and likely. Markets are already discounting an improving global economy in 2014. In our view, increased upside risks remain for both bond yields and equity prices, particularly in light of lingering investor uncertainty and cautious positioning. The imminent beginning of Fed tapering represents a possible source of volatility, but G7 central banks remain committed to monetary reflation, and conditions should remain supportive for risk assets.
Although stocks are vulnerable to a correction in the near term, given recent significant strength, we continue to advocate a moderately pro-equity and growth posture on a six- to 12-month time horizon. Skepticism about the fundamentals and durability of the equity rally is widespread, with many investors arguing that equities are expensive and profit margins are unsustainably high. We do not foresee a major risk to 2014 performance as long as the global economy shows an improving trend. A key risk to our forecast is a relapse into recession that could be caused by a policy mistake or a bond market blowup, but we don't think this is likely.
Robert C. Doll is chief equity strategist and senior portfolio manager at Nuveen Asset Management.