Key Points

• Investor sentiment remains uneven, but we believe the fundamental backdrop is stronger than many believe.
• Financial markets have proven to be resilient to negative economic news and a number of near-term global risks. We think that is positive for equity prices.

Equity markets were mixed last week, rising in the first half of the week before declining. Signs of stabilization in China and a lower likelihood of near-term Federal Reserve tightening helped markets, while economic growth worries, the upcoming referendum in England to determine whether to remain a part of the European Union (the “Brexit” vote) and falling bond yields weighed on stocks. For the week, the S&P 500 Index declined a modest 0.1%.1

Investor Sentiment Remains Mixed at Best

As usual, the bulls and bears have different outlooks. The bulls point to cautious sentiment, reasonable valuations, relatively stable growth conditions and prospects for better earnings results as reasons to be positive toward equities. The bears, in contrast, believe earning are unlikely to improve (meaning valuations are stretched), and focus on unresolved big-picture risks such as Chinese growth, Brexit and the uncertain U.S. elections. In our view, fundamentals lie somewhere in between. We agree there are reasons to worry, but think the fundamental backdrop is stronger than the bears believe.

Weekly Top Themes

1. The weak May employment report continues to weigh on sentiment, but should be kept in perspective. Last month’s jobs report is hardly the first time a monthly reading has disappointed. In fact, May marks the sixth time in the last five years we have seen a disappointment of this approximate magnitude.2 The jobs data does not call into question the overall health of the economy, but does increase uncertainty over Fed policy.

2. The nature of the labor market is shifting. As the current economic expansion matures and as the U.S. approaches full employment, it is no surprise that the pace of jobs growth is slowing. Wages have been rising, which should help consumer spending remain solid. We also expect productivity levels to improve, which should boost both wages and corporate profits.

3. Corporate earnings should experience uneven improvement. We believe we are past the worst of the drags from the oil rout/soaring dollar. Earnings should trend higher, but the path will remain rocky.

4. Corporate buybacks and other shareholder-friendly activities should be a plus for equity prices. S&P 500 companies repurchased $165 billion worth of stock in the first quarter, the strongest pace since the third quarter of 2007 and the second-highest level in history.3 With corporate cash levels high, we expect buybacks and dividend increases will continue.

5. Non-U.S. equities have lagged their domestic counterparts. Although U.S. markets are approaching their all-time highs, other regions remain far from that milestone. U.K. stocks are 11% below their all-time highs, while Germany is off 17% and China and Japan lag by more than 50%.4

Financial Markets Are Starting to Show Resilience

Over the last several weeks, we have continued to see mixed economic news and flare-ups in global risks, but markets appear to be showing tentative signs of resilience. The latest worries include the downturn in the U.S. labor market, the upcoming U.K. referendum and uncertainty over Fed policy.

Despite these concerns, stock prices have not sold off and the U.S. dollar has remained resilient in the face of negative economic news and lowered rate increase expectations. While Treasury yields resumed their downturn, the pace has not been as sharp as might have been expected, especially given the sharp decline by German government bond yields into negative territory. Oil prices have been rising due to supply disruptions, but we expect oil to remain range-bound, since drilling and output have the capacity to increase if prices continue to rise.