Highlights

• Economic growth looks to be accelerating, although trade issues and rising interest rates are potential risks.

• We don’t believe trade concerns will ease any time soon, but they should not derail the current global economic expansion.

• Over the next year, non-U.S. stocks may assume a leadership position relative to U.S. markets.

The Dow Jones Industrial Average and S&P 500 Index both hit new record highs last week as investors focused on positive economic news and looked past ongoing trade issues.¹ The S&P 500 was up 0.9 percent for the week.¹ The materials, financials, energy and industrials sectors led the way, while defensive areas like REITs and utilities lagged.¹ Bond markets were in focus last week as the Treasury selloff continued. The 10-year Treasury yield pushed as high as 3.09 percent last week, close to the 2018 high of 3.12 percent it reached in May.¹

Weekly Top Themes

1. The Federal Reserve is likely to raise rates again this week, but monetary policy will be tougher to gauge from here. The fed funds rate is approaching neutral, meaning policymakers must increasingly balance upside and downside risks.

2. Rising wages should help economic growth to continue accelerating. This could present a risk for the Fed if the economy starts overheating.

3. The economic cycle may be in its later stages, but growth can still continue. The fed funds rate is still relatively low given still modest inflation. We also think the ongoing effects of tax cuts, higher capital spending and a healthy consumer sector will help keep this economy going.

4. Trade tensions are likely to continue escalating. Investors mostly shrugged off the Trump Administration’s latest tariff announcements, but a near-term deal with China looks unlikely. We do not expect tensions to ease until at least after the midterms.

5. Rising interest rates may become increasingly problematic. We have already seen signs of higher business and household borrowing costs. Should rates continue to move higher, consumption and investment growth could slow next year.

6. Corporate earnings remain strong, but expectations may be too high. S&P 500 earnings are on track to be around $160 by the end of 2018.¹ Consensus expectations are for another year of double-digit growth in 2019, but we think that is unlikely.¹ Our guess is that earnings may grow to $170 next year—still representing a positive trend, but one that could disappoint current expectations.

7. Polling suggests prospects for Democrats are improving as we approach the midterms. We think Democrats will likely win the House of Representatives, but expect the GOP to hold on to the Senate. A full Democratic sweep, however, is looking like a greater possibility.

The Next Risk-On Move In Stocks Could Favor Non-U.S. Equities

As economic data has improved recently, investors seem less concerned about rising trade tensions. Trade issues could continue to increase, leading to a fullblown trade war that could derail the global economy, but we do not believe such an outcome is likely. Nevertheless, trade issues remain a serious risk and bear close watching.

Ironically, non-U.S. stocks have been hurt much more by trade worries over the past few months than have U.S. equities. Much of this dispersion has resulted from the corresponding climb in the U.S. dollar, which has made U.S. stocks a relatively safer haven. The fall in global stock prices has probably been excessive, and seems to reflect worse economic and fundamental conditions than actually exist.

Last year, many investors focused on the relative valuation advantages offered by non-U.S. stocks and believed they were poised to outperform U.S. markets. At this point, we think that if trade conditions ease (or if we see more clarity about the direction of trade policy), it would boost global equity markets. Additionally, if global bond yields avoid sharp increases and experience an orderly rise, that would likely remove some risk from the equation.

Overall, we continue to have a pro-growth stance toward global financial markets. For now, we think U.S. stocks are supported by relative economic conditions, monetary and fiscal policy trends and the political backdrop. But these trends may reverse, or at least become less strong, over the next 6 to 12 months, which could benefit non-U.S. markets.

Robert C. Doll is senior portfolio manager and chief equity strategist at Nuveen Asset Management.

 

1 Source: Morningstar Direct, Bloomberg and FactSet