• Coronavirus-related economic fears continue to dominate markets, but we believe effects will be short term and limited.
• Once investors begin to look past near-term risks, we think areas of the global financial market that have benefited on a relative basis (growth styles, defensive areas and bond market proxies) could take a hit.
• On balance, we think the equity bull market should continue, but we are concerned that valuations look stretched in some areas.

Investor attention remains dominated by the possible economic impacts of the coronavirus. Investors had temporarily returned to a risk-on stance, on hopes that the virus had peaked, but a more defensive flight-to-quality trade took hold last week on news of additional outbreaks. For the week, the S&P 500 Index fell 1.2%.1 The technology and financial sectors led the way lower, while more defensive areas held up better.1 Treasury yields also fell last week, with the yield curve flattening slightly.1

Weekly Top Themes

1. Despite near-term risks, we expect coronavirus-related economic issues to be contained. Markets have been in a risk-off mode, with more defensive and growth areas of the equity market outperforming in 2020. In our view, economic conditions would have to worsen significantly for this trend to continue, which we think is unlikely.

2. We believe 2020 will still be a year of economic recovery. Before the virus, economic optimism was rising given easing trade issues. We still think the global economic positives outweigh the near-term risks, and expect the U.S. and global economies will accelerate modestly this year.

3. While inflation is not a problem, it does appear to be picking up. The January Producer Price Index showed a 0.5% increase, the strongest advance since October 2018.2 This came despite falling energy prices, as prices increased across services, construction and core goods.

4. Equity markets may be vulnerable to a correction. Following surprisingly strong returns in 2019, U.S. equity markets have continued to advance in 2020, despite the coronavirus fears. At the same time, earnings expectations have been falling. The combination of rising prices and declining earnings expectations may have pushed some areas of the market to be overvalued.

5. In particular, we are concerned that some growth, momentum and defensive areas look vulnerable. These areas have been outperforming on a relative basis for some time and appear stretched. In our view, once investors look past near-term risks and focus on the prospects for better long-term economic growth, this trade could reverse.

6. Likewise, the U.S. dollar could be overvalued. The strength of the dollar is somewhat counterintuitive, given the size and growth of the U.S. budget and current account deficits. But the increase appears to be part of the broader flight-to-quality trade that could unwind if and when coronavirus concerns fade.

7. Related to all of this, non-U.S. stocks could start to outperform. Most global markets are in negative territory for 2020, but U.S. stocks have posted gains. In our view, this is largely because the U.S. market is more growth-oriented with a higher relative weighting in bond-market proxies. An environment of better global economic growth should help non-U.S. markets on a relative basis.

Equity Valuations Are High And This Bull Market Is Old—But That Doesn’t Mean A Bear Market Is Imminent

Most investors seem to expect the economic damage from the coronavirus will be moderate and largely contained, likely pushing back an economic rebound rather than derailing it. The extent of negative effects on corporate earnings is an important wildcard. Expectations for 2020 earnings growth had already been declining before the virus hit, and forward guidance from corporate management teams has trended more negative as results have been released.

We expect additional near-term disruptions to global economic growth in the coming months, especially as it relates to manufacturing and trade levels. We have already seen significant damage to the Chinese economy. And Europe (which has a much more export-oriented economy than the United States) is showing negative effects on growth. The economic silver lining of the coronavirus is that economic worries have suppressed bond yields and delayed a possible shift to tighter monetary conditions. Central banks remain extremely accommodative and show no signs of shifting policy, despite resilience in the service and consumer sectors.

From a markets perspective, investors appear more optimistic about longer-term growth prospects than at any point during the 11-year-old recovery and expansion. Investors strongly believe that central banks will be able to stave off recession, despite coronavirus-related risks. The bearish interpretation of such a backdrop is that investors are overly complacent. We believe this is a typical indication of a late-cycle bull market. We think equity valuations look stretched, especially for the more defensive, growth-oriented and bond-like sectors. We would not be surprised to see additional volatility and some corrective action (especially within the more highly-valued areas of the market), but no near-term catalysts are emerging that would cause a recession or actual end to the equity bull market.

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

1 Source: Bloomberg, Morningstar and FactSet
2 Source: Department of Labor