In contrast, the negatives include:
1. Earnings remain shaky and improvements are probably necessary for equities to experience a sustained move higher.
2. Investors may be overly complacent about Federal Reserve rate hikes.
3. Global growth is likely to remain anemic.
4. The U.S. political backdrop is highly uncertain.
5. Regulatory scrutiny over mergers and acquisitions appears to be growing, which may suppress this equity-friendly activity.
Despite a Solid Outlook, Sentiment Remains Depressed
A back-and-forth in markets has been the theme that has dominated 2016. Markets pulled back over the past several weeks after rallying from mid-February through mid-April. In retrospect, it shouldn’t be surprising that this rally faded. Investor sentiment has remained weak and investors are defensively positioned, continuing to hold large amounts of cash. This suggests the recent rally was a result of short covering and a sense that recession and deflation risks were fading, rather than coming about through growing optimism. In other words, investors may believe that conditions aren’t as dire as they thought early in the year, but they are hardly optimistic about earnings and economic growth prospects.
Overall, we think the positives will win out over the negatives, but near-term concerns mean risk assets are unlikely to move up in a straight line. The current risks and hurdles include next month’s referendum on whether the U.K. will leave the European Union, the prospect of a more aggressive than expected pace of Fed rate hikes and the possibility of another downturn in oil prices. We think the odds are better than not that markets will weather these potential storms. But given the fragile state of sentiment, it wouldn’t take much for equities to experience another sell-off or consolidation.
Ultimately, we think investors need evidence that corporate earnings have recovered before they will feel more comfortable moving back into equity investments. We expect this evidence will materialize over the coming quarters, which is why we believe equities will outpace bonds and cash over the next six to twelve months. But investors will be slow to embrace good news and there is still ample reason for caution. As such, we think volatility will remain elevated.
1 Source: Morningstar Direct, as of 5/13/16
2 Source: Commerce Department
3 Source: University of Michigan
Bob Doll is chief equity strategist at Nuveen Asset Management.