U.S. equities declined again last week, with the S&P 500 Index losing 0.7%, although the damage was mitigated by a rally on Friday that followed a stronger-than-expected employment report. The pending completion of the Federal Reserve's quantitative easing program was one catalyst for the sell-off, as were broader concerns about global economic growth and the continued strength of the U.S. dollar. Oil prices declined sharply, driven by the rising dollar, growth concerns and increasing supply.
Market Correction Fears Are Rising
Equity prices have been falling for the past couple of weeks and from peak to trough are now down around 5%. This exceeds the 4% sell-offs we saw in August and April, but is less than the 7% downturn we witnessed in January. Since economic and market fundamentals haven't shifted notably in recent weeks, it appears that this pullback is being driven by a heightened focus on previously existing risks, chiefly worries about global growth, geopolitical tensions and a pending shift in monetary policy. Although these worries are not new, they are coinciding with a general sense among investors that markets are overdue for a correction.
Friday's jump in stock prices could mark the end of the current slide, or may simply be a blip in the midst of a more pronounced pullback. Either way, we believe relatively higher levels of volatility will persist as markets continue to look sloppy.
Strong jobs growth points to an accelerating economy. Friday's employment report showed that 248,000 new jobs were created in September, surpassing expectations. Additionally, numbers for the preceding two months were revised upward, and the headline unemployment rate fell to 5.9%.
The U.S. economy is diverging from other markets. Last week's announcement by Ford Motor Company that issues in Russia, the Eurozone and Brazil were hurting sales served as an important reminder that U.S. growth is stronger than in many other areas of the world.
Several market trends have gained traction and could persist: weak performance by U.S. small cap stocks, commodity prices coming under pressure and the U.S. dollar strengthening. The combination of a strengthening dollar and a pullback in commodity prices is also putting pressure on emerging market equities.
Commodity price weakness can largely be attributed to slower global economic growth. The slowdown in China in particular has hurt industrial commodity prices. Chinese authorities are continuing to engineer a growth slowdown, which is one reason we believe commodity prices should continue to drift lower.
We think the odds of a Republican takeover of the U.S. Senate are climbing. If the GOP takes control of the Senate, we think it would be a positive for the energy industry, medical device companies and defense stocks but a negative for hospitals and HMOs.
The U.S. Economy Continues to Outpace Other Regions
U.S. economic growth has been uneven, but continues to accelerate. We have seen a number of potential stumbling blocks over the past few years, but this economy has proven to be highly resilient, and we do not believe its current trajectory will be derailed. Outside of the United States, in contrast, economic risks appear to be rising. Europe is a notable global weak spot and the engineered slowdown in China remains a concern.
Divergence between the United States and other markets remains a growing theme. Slower global growth is benefitting the U.S. economy in some ways, such as via lower commodity prices. But at some point this divergence could put pressure on U.S. multinational corporate earnings and act as a headwind for U.S. growth through such factors as declining exports.
In any case, we believe the current backdrop should be supportive for most risk assets (with commodities being a notable exception). Volatility is rising, and periodic market setbacks are inevitable, but the long-term case for equities remains sound.
Robert C. Doll is chief equity strategist and senior portfolio manager at Nuveen Asset Management. This post first appeared here.