Highlights

• We expect U.S. economic growth to accelerate even as some other areas of the world economy are fraying around the margins. Likewise, we think inflation will continue to move modestly higher.                

• This should create tailwinds for stocks, but we think headwinds such as mounting trade issues need to fade before equity markets can break out of their trading ranges.                 

• We continue to believe equities will outperform bonds this year, but also anticipate volatility may remain relatively elevated.

So far, 2018 has been a year of contradictions. Corporate earnings growth has been stellar, yet stock prices have been stuck in a one-step-forward, one-step- back mode. Economic growth in the United States is accelerating and inflation is rising, yet bond yields remain stubbornly low. Wage growth is also struggling to move higher even as unemployment falls to its lowest level in 50 years and the Federal Reserve continues to raise interest rates. The political environment (both in the United States and around the world) remains uncertain, but has not negatively affected financial market fundamentals. Despite this confusion, the long-term backdrop still looks promising for economic growth and for equities, and we don’t believe this bull market is ending.

Mid-Year Scorecard

Prediction 1

U.S. real GDP reaches 3 percent and nominal GDP 5 percent for the first time in over a decade.

First quarter economic growth came in at a relatively slow 2.2 percent, but current expectations are for growth in the second quarter to be over 3 percent.¹ We expect growth to rebound and accelerate, especially given the strength in the labor market, a tailwind from additional fiscal stimulus and rising capital expenditures. With inflation climbing modestly, we also believe that nominal growth should climb.

Prediction 2

Despite ongoing protectionism, the global expansion continues with the fewest countries in recession in history.

Rising trade protectionism remains a threat to the global economy, and it is one that increased in recent weeks. So far, however, the world economy has been able to look past these issues. While growth in some parts of the world may be slowing, the overall world economy remains in very good shape.

Prediction 3

Unemployment falls to the lowest level in nearly 50 years as wage growth is the highest since the Great Recession.

The first half of this prediction has come to pass as unemployment is down to 3.9 percent, matching its lowest rate in 50 years.² Wage growth has slowly risen from 2.5 percent to 2.7 percent this year, and we expect it will get to 3 percent by the end of 2018.²

Prediction 4

The yield curve flattens (but does not invert) as the 10-year Treasury yield reaches 3 percent for the first time since 2014.

Bond yields remain surprisingly low, yet the yield on the 10-year Treasury crossed the 3 percent mark earlier this year and peaked at 3.11 percent on 17 May.³ The spread between the 2-year and 10-year Treasury yield narrowed from 52 basis points to 35 by the end of last week.³ We expect both modest flattening of the yield curve and unevenly rising yields to continue.

Prediction 5

Stocks enjoy longest bull market in history but experience a 5+ percent correction after the longest period without one.

The second half of this prediction already happened in February when stocks experienced their first significant correction since 2016.3 Should equity markets make it to August 22 this year without the bull market ending, the first half of this prediction will come true as well.⁴

Prediction 6

U.S. equity returns lag earnings growth for the first time in six years, the longest streak in decades.

So far, this prediction is probably our “most correct” of the year, since earnings growth has been amazingly strong while stock prices have advanced only modestly. Estimated 2018 earnings-per-share growth for S&P 500 companies stands at 20.1 percent year over year, while the S&P 500 Index has returned 4.0 percent.³ It would take a massive collapse in earnings and/or a sharp jump in prices for this prediction to move into the “wrong” column.

Prediction 7

Equities beat bonds for the seventh consecutive year for the first time in nearly a century.

As of the end of last week, the S&P 500 Index was up 4.0 percent, while the Bloomberg Barclays U.S. Aggregate Bond Index was down 2.0 percent.³ We expect both markets to remain volatile over the next six months, but given the economic growth, earnings and inflation backdrop, we think this prediction is likely to remain correct.

Prediction 8

Corporate capital expenditures increase at the expense of share buybacks.

Capital expenditure levels are picking up, which is boosting productivity and should help the economic expansion to continue. As of May, the Instituite for Supply Management is forecasting capex spending will be up an increadible 10.1 percent in 2018.5 Share buybacks have also increased, however, which makes this prediction a bit muddled. Should capex levels continue to pick up, we may be able to mark this one correct by the end of the year.

Prediction 9

Telecommunication services, information technology and health care outperform utilities, energy and materials.

This prediction is trending in the right direction so far. A basket of our most-favored sectors is up 2.5 percent, while a basket of our least-favored is trailing at 0.5 percent as of the end of last week.³ Assuming economic growth continues to improve, we think this prediction will remain in the correct column.

Prediction 10

Republicans lose the House, retain the Senate and further distance themselves from President Trump.

Political futures are about as volatile as equity markets, and five months can be a lifetime for politics. Absent a significant shift in the political landscape, however, we expect Democrats will be able to take the House of Representatives in November, although the Senate is less likely to see a leadership change. Many Republicans have been distancing themselves from the president, with the latest divide coming from President Trump’s immigration policies.

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

 

1 Source: Source: Commerce Department

2 Source: Source: Bureau of Labor Statistics

3 Source: Source: Morningstar Direct, Bloomberg and FactSet

4 Source: Bank of America Merrill Lynch Research

5 Source: Institute for Supply Management and Strategas Research