The Bullish Case Is More Compelling Than the Bearish

Key Points

▪ Following a strong post-Brexit rally, equity prices have stabilized in recent weeks.

▪ A number of positive factors could push prices higher, but these are balanced by several risks.

▪ On balance, we think the positives outweigh the negatives, but caution that markets are likely to remain uneven.

Most financial market developments occurred outside of equity markets last week. The U.S. dollar came under pressure following a generally dovish tone from the July Federal Reserve policy meeting minutes. Oil prices continued to advance amid ongoing speculation about production cuts. U.S. equities were up modestly last week, with cyclical areas such as banks, semi-conductors, autos, materials and energy leading the way.1 Real estate, telecommunications, drug companies and utilities lagged.1

Weekly Top Themes

1. U.S. manufacturing activity is likely to accelerate. Retail sales have been solid and manufacturing inventories have been declining.2 This combination suggests a modest pickup in manufacturing in the third quarter.

2. We expect a Fed rate hike later this year. A September increase is a possibility, but unlikely. We think December is a better bet.

3. It is hard to see how the United Kingdom will avoid a recession. The postBrexit rules could take years to be finalized, creating ongoing uncertainty for businesses. The silver lining is that Brexit effects remain contained, meaning that a UK recession will not necessarily expand to the eurozone.

4. Low bond yields remain supportive of equity prices. While we expect upward pressure on bond yields due to improving economic growth, the Fed and other central banks remain acutely attuned to keeping financial conditions stable and are unlikely to tighten policy quickly or dramatically. As such, bond yields are unlikely to increase sharply.

5. It will be difficult, however, for equity prices to advance without additional support. Equity indices have again hit new records, but we believe fundamental changes may be necessary for prices to continue advancing strongly. Specifically, earnings would have to improve further and/or investor flows would have to turn notably toward stocks. Neither is out of the question, but aren’t likely.

The Back-and-Forth in Stocks Will Likely Persist
Since the initial fallout from the Brexit vote, U.S. stocks experienced a strong rally and have been trading sideways and marginally higher. This sparked the all-toofamiliar bull versus bear debate, leading us to list the positive and negative factors for equities.

Reasons to be positive: 1) If yields remain low, equity valuations should have room to advance. 2) Earnings have been improving modestly and forward guidance has been solid. 3) Global policymakers have been hinting at fiscal stimulus and we expect increased spending in the U.S. regardless of the outcome of November’s elections. 4) The U.S. political outlook is becoming clearer, and it appears our government will continue to be divided (which isn’t necessarily bad for financial markets). 5) The global banking system remains reasonably healthy thanks to decent balance sheets. 6) Brexit-related risks appear contained. 7) U.S. economic growth is reasonably solid and the global economy appears on track, outside of the UK. 8) Oil prices have stabilized and have become less of a factor driving equity markets. 9) Chinese currency risks have diminished as price depreciation has been steady and even. 10) Bipartisan support for corporate tax reform appears to be growing and could occur in 2017.

Reasons to be cautious: 1) Global government bond yields appear artificially low and a possible spike could disrupt financial markets. 2) Central banks have exhausted their policy options and have little ability to respond to any new crises. 3) Financial markets appear overly complacent about the prospects for Fed rate hikes. 4) Expectations for future corporate earnings may be too high. 5) Additional fiscal stimulus and a lack of monetary policy options could put upward pressure on global bond yields. 6) Several months remain before the U.S. elections, and uncertainty levels could rise again. 7) Geopolitical uncertainty and terrorism risks (especially of the lone wolf variety) remain high.

On balance, we think the positives will outweigh the negatives, but the frustrating, back-and-forth in stock prices we have seen all year is likely to persist.

1 Source: Morningstar Direct, as of 8/19/16
2 Source: Commerce Department

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.


The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.

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