Nuveen: This Economic Cycle Should Continue, But Volatility May Rise
This economic cycle should continue, but volatility may rise
- Stock prices rallied last week, helped by the removal of some political uncertainty following the midterms.
- We think economic growth will slow a bit next year, but should be strong enough to remain supportive of equity markets.
- In our view, trade issues represent the most serious threat to U.S. and global economic growth.
U.S. equities continued their strong rally in the first half of last week, but lost some momentum as the week drew to a close.1 The S&P 500 Index advanced 2.2%, as every market sector except communication services gained ground.1 Health care, REITS, utilities and consumer staples led the way to the upside.1 Shifts in the bond market were in focus last week as the yield curve flattened.1 The 2-year Treasury yield rose to nearly 3%, touching its highest level in over 10 years.1
Weekly top themes
1) The U.S. midterms played out largely as expected. We think policy implications on the economy and financial market will be minimal over the next two years, especially since the chances of significant changes to tax policy are virtually nonexistent.
2) An infrastructure deal looks unlikely. With deficits high and rising, it would be hard to find a way to pay for much new spending, even if Republicans and Democrats could come together on a plan.
3) We also don’t expect much movement in health care reform. We could see some changes to prescription drug pricing laws, but not much else. Overall, the status quo is probably good news for the health care sector.
4) Consumer sentiment remains solid despite last month’s selloff in stocks. The University of Michigan’s consumer sentiment index slipped only slightly from 98.6 in October to 98.3 in a preliminary November reading.2 This resilience suggests consumer spending should remain decent over the next several months.
5) Third quarter earnings results were once again strong. As the reporting season winds down, revenues are on track to grow 8% and earnings 25% year-over-year.3 Forward guidance, however, has been weakening as management teams are worried about trade policy and higher labor costs.
6) Oil prices continue to fall. Friday marked the tenth consecutive day of lower prices. Oil is now down 20% from its early October highs.1
7) Even if economic fundamentals remain sound, market volatility could rise. Investor uncertainty over issues such as trade policy, tariffs, the U.S. budget, congressional investigations of the Trump Administration and Fed policy could all trigger more volatility across financial markets.
Trade risks are elevated, but we think the pro-growth environment should persist
Up until October, investors appeared quite sanguine about the state of the economy and confident when it came to the financial markets outlook. The recent equity market correction and rise in volatility, however, has changed that. While there are number of risks, it appears investors are most focused on trade policy uncertainty and worries about rising interest rates.
We agree that trade issues represent a serious concern. If the Trump Administration carries through on its plans to enact a blanket 25% tariff on all Chinese goods, that could well damage U.S. and global economic growth, especially if it results in retaliatory actions and a broadening of higher tariffs around the world.
In contrast, we don’t think higher interest rates represent a significant near-term threat to either the U.S. economy or the equity market. Interest rates are still low by historic standards. And more to the point, we think they are low relative to current economic growth levels. Rates would need to climb higher and faster to cause a growth disruption.
We expect U.S. economic growth to cool over the coming year, but remain decent. Our best guess is that real gross domestic product growth will drop from around 3% in 2018 to closer to 2.5% in 2019 as monetary and fiscal policy become less supportive.
In this environment, we think interest rates and inflation will continue to rise modestly, which will put bond markets under pressure (in particular government bonds). Given lingering global economic uncertainty and trade policy risks, we think it makes sense to stick with neutral weightings for stocks, at least until more clarity emerges. And that would imply an overweight to cash for the time being. Equity markets may experience some increased headwinds and higher volatility, but we continue to believe that stocks are likely to outperform bonds over the course of next year.
Source: https://www.nuveen.com/bob-doll-weekly-commentary