Key Points
▪ We believe investors are overly complacent about the state of the global economy and the political backdrop.
▪ We remain cautiously optimistic toward equities, but think the pace of recent gains is unlikely to persist and that risks will rise this year.
Can the Equity Rally Continue?
Equity markets have increased since the U.S. elections for two principal reasons: optimism over a pro-growth legislative agenda from Donald Trump and improving U.S. and global economic and earnings growth.
The second factor actually began emerging in mid-2016. The S&P 500 Index advanced close to 7% between its summertime low and Election Day, and has subsequently risen nearly 10%.1 Since this time last year, when investors were focused on deflation and recession risks, the S&P 500 has climbed nearly 30%.1 Bond yields have also risen significantly in recent months: the 10-year Treasury yield climbed close to 50 basis points since the election and more than 100 basis points since the mid-2016 lows.1
Simply put, we do not believe this pace of gains is sustainable. We think that economic growth will continue improving and the economy and markets will benefit from the legislative backdrop. But the intense pace of gains implies that investors believe both trends will persist without interruption. We think this is unlikely and expect bumps along the way in economic and earnings data. The political environment will also likely provide its share of setbacks.
Investors May Be Looking Past Economic Risks
For several years, the U.S. economy has benefited from a Goldilocks scenario of low inflation and supportive monetary policy that has allowed slow, but consistently positive growth. We think the economy is now moving into a slightly higher gear. Falling unemployment and slowly rising wages are boosting consumer spending. Corporations are increasing spending levels and engaging in equity-friendly practices such as dividend increases and merger activities. Additionally, while the Federal Reserve is starting to raise interest rates, policy remains extremely accommodative and should help economic growth.
Outside of the United States, we also see reasons for optimism. Brexit risks notwithstanding, the eurozone appears to be recovering. In China, fears of a hard landing have receded and worries over a disorderly currency devaluation have faded as Chinese policymakers have ramped up their own fiscal stimulus to help the economy.
And we would also point out that the corporate earnings backdrop is also improving. A key drag on earnings—rapidly falling oil prices—has probably run its course. And the quickly rising dollar remains present but has moderated.
At some point, however, conditions for continued growth may become trickier, and the economic environment will likely grow more uncertain. Inflation appears to be climbing slowly and interest rates have probably bottomed. A stronger dollar also presents a risk. Together, these factors may conspire to tighten financial conditions. We don’t expect these trends to emerge quickly, but believe the Goldilocks environment driving growth will likely begin fading by the end of 2017.
In short, we remain constructive on the U.S. and global economic outlooks, but believe that anxiety and economic volatility will probably rise. We think economic growth will remain solid for some time, but risks are growing that the U.S. and global economies will falter in 2018.
The Political Environment Is Becoming More Complicated
For months, the direction of the stock market has closely tracked the political backdrop. When President Trump has focused on possible tax cuts or regulatory changes, equities have generally increased. But markets faltered when he turned his attention to limiting trade or immigration. At some point, we expect investors will more closely scrutinize President Trump’s actual policy actions rather than his rhetoric.
Despite the wide-sweeping nature of many of Donald Trump’s statements, the reality is that the Constitution requires the president to work with Congress to enact legislation. And the judiciary acts as an important check against presidential overreach.
From a practical perspective, this means that the actual tax, spending and regulatory policies the Trump Administration are promising will likely be less far-reaching than many investors hope. We think Washington will pass a fiscal stimulus package, but it will probably take longer than most expect and the scope may well be more modest. The same is likely true with tax reform.
Additionally, the fiscal tone from Washington is somewhat concerning from a budget perspective. President Trump talks about tax cuts, but also discusses areas to increase spending, such as the military. It is unclear how much Congress shares this focus, but we think investors are overly optimistic about the legislative agenda.
We Have Grown Less Bullish Toward Stocks
As a result of these developments, we think the easy gains for equities are in the rearview mirror and we are growing less positive toward the stock market. We do not believe the current bull market has ended, but the pace and magnitude of the gains we have seen over the past year are unlikely to persist.
To be clear, this does not mean we have turned negative toward equities, but we think markets may be vulnerable to negative economic, earnings or political surprises. Market sentiment has improved over the past year while valuations have become less attractive.1 It is somewhat worrisome that investors are becoming more complacent. On balance, we think the near- and long-term equity outlook remains reasonable given the economic and earnings backdrop. It is just that with the S&P 500 currently sitting at around 2,350 at least some positive expectations are already baked into the market.1
From a positioning perspective, we think it still makes sense to remain overweight equities and underweight government bonds. If evidence mounts to reveal a slowing economy or faltering earnings, we would revisit this stance, but we do not expect that to happen for at least the balance of the rest of this year.
Over the short-term, we would point out that markets really haven’t had much of a pause or correction in recent months, which could mean stocks are overdue for some sort of setback. Over the long-term, we still expect equity prices to continue climbing. But increases will likely be uneven, with greater dispersion and more significant downside risks. ▪
1 Source: Morningstar Direct and Bloomberg, as of 2/17/17
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.
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors.
A WORD ON RISK
This information represents the opinion of Nuveen Asset Management, LLC and is not intended to be a forecast of future events and this is no guarantee of any future result. Information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. 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. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute. Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.
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