Key Points
▪ Rising uncertainty surrounding the U.S. elections caused volatility to rise and equity prices to sink.
▪ Economic and earnings data have been improving and point to better results for stocks over the next six to twelve months.
▪ We suggest investors not overreact to any possible elections-related volatility.
Last week saw a clear risk-off trend, as U.S. political uncertainty rose in advance of this week’s elections. Equity prices fell, with the S&P 500 Index declining 1.9% for the week.1 Friday marked the ninth consecutive trading day of losses for stocks.1 This represents the longest streak since 1980, although the total decline has been relatively modest at around 3%.1 In other asset classes, U.S. Treasury yields fell slightly, the U.S. dollar weakened, gold prices rose and oil prices fell sharply.1
Weekly Top Themes
1. The third quarter should mark the end of the long earnings recession. With more than 85% of S&P 500 companies reporting, earnings are up about 3% for the quarter year-over-year.2 This represents the first positive quarter since the first quarter of 2015.2
2. The likelihood is growing for a Fed rate increase in December. Not surprisingly, the Federal Reserve did not increase rates at its November policy meeting. Fed officials hinted that a rate increase next month was probable. As of Friday’s market close, the market-based probability of a December hike was 67%.1
3. The labor market continues to strengthen. The most important economic data point last week was probably the October jobs report. Last month saw 161,000 new jobs created, while the unemployment rate dropped to 4.9%.3
4. The jobs market is tightening, putting upward pressure on wages. In addition to the decent headline numbers, October’s jobs report also showed average hourly earnings accelerated to a 2.8% annual rate.3 This marks the highest level of wage growth since the 2008/2009 financial crisis.3 A tighter labor market is a classic sign of a maturing economic expansion.
5. Overall inflation is starting to tick higher. In addition to wage growth, we have been seeing signs that health care, housing and education costs are also increasing. Inflation may cause a drag on consumer spending and broader economic growth in the months ahead.
Volatility May Persist, but Equities Should Move Higher
With solid economic data and positive corporate earnings trends, it would be natural to assume that stock prices should be advancing. That, of course, hasn’t been the case in recent weeks. The obvious culprit is rising uncertainty surrounding the U.S. elections. As presidential polling has tightened, investors have been faced with the question of whether they should move to the sidelines and await the results before putting cash to work, or maintain their existing positions and hope for the best. From our view, it makes sense to maintain a mildly upbeat stance on risk assets for two reasons.
First, from a political perspective, we think it is more likely than not that Hillary Clinton will be elected president. Regardless of voters’ opinions, Clinton’s policies would be more predictable than those of Donald Trump, and if there is one thing that financial markets like, it is predictability. If we are wrong in our forecast, and Donald Trump does win the election, we expect additional volatility and a likely sell-off in risk assets. In this case, we would maintain positions in equities and other risk assets until there is greater clarity about Trump’s policies.
Secondly, and more importantly, we expect markets will again focus on fundamentals after the election. And fundamentals point to an environment that should be conducive to better performance for risk assets. Global economic growth is improving unevenly in the United States, China and Europe, while the world’s major central banks remain accommodative and are firmly pushing pro-growth agendas. At the same time, the headwinds of collapsing oil prices and a surging U.S. dollar that dragged down corporate earnings over the last 18 months have finally faded.
Over the next six to twelve months, we expect financial markets to be choppy. We believe equity prices should move higher and bond yields will rise. In such an environment, we think it makes sense to overweight equities versus bonds and cash, and focus on fixed income credit sectors over government bonds. Within equities, we believe U.S. stocks look more attractive than most international markets given stronger growth levels and a more supportive earnings outlook.
1 Source: Morningstar Direct and Bloomberg, as of 11/4/16
2 Source: FactSet
3 Source: Bureau of Labor Statistics
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. The Russell 2000 Index measures the performance approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone.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. Bloomberg 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.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
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. Non-investment-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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