Highlights

• While the Fed cut interest rates last week, fading prospects for additional cuts beyond one more hurt market sentiment

• The announcement of new tariffs further damaged confidence and suggests the trade war will persist for some time.

• We think the global economic expansion can still continue, but investing will become more difficult from here.

Equity markets around the world moved lower last week, with the S&P 500 Index dropping 3.1% for its worst weekly performance of the year.¹ As widely expected, the Federal Reserve cut interest rates for the first time since 2008, but expectations for future rate cuts fell. Additionally, President Trump’s announcement of new tariffs on Chinese goods hurt investor sentiment. Treasury markets rallied across the yield curve last week, and defensive utilities and REITs were the only equity sectors to make gains.¹

10 Themes For Investors To Consider:

1. The announcement of new tariffs shows the trade war is here to stay. President Trump’s announcement of a 10% tariff on $300 billion worth of Chinese goods comes on top of the $250 billion of goods that already face a 25% tariff. The president appears to believe that Chinese authorities are unlikely to agree to a trade deal before the U.S. 2020 elections. The decision could potentially be delayed or reversed before the new tariffs go into effect in September, but we believe both countries must experience further pain before they can reach an agreement.

2. The prospects for additional Fed rate cuts have been lowered. At the press conference following last week’s 25-basis point rate cut, Chairman Powell indicated that only a U.S. recession would trigger a long series of further cuts. We expect perhaps one additional cut this fall before the Fed adopts a wait-and-see approach.

3. The labor market remains solid, but is slowing. Non-farm payroll growth fell to 164,000 in July, and previous months’ figures were revised downward.² Unemployment remains at 3.7% and average hourly earnings increased slightly to an annual 3.2% pace.²

4. The U.S. business cycle appears to be in its latter stages. The 2019 annual GDP benchmark revisions showed a jump in employee compensation.³ That’s good news for consumers, but bad news for corporate profit margins. We think the revisions suggest the business cycle is in a later stage than many previously thought.

5. We expect U.S. dollar strength will reverse at some point. Stronger U.S. growth and higher relative interest rates have boosted the value of the dollar. We think the large budget and trade deficits should contribute to eventual dollar weakness.

6. Possible market risks associated with the 2020 election appear to be growing. With the notable exception of Joe Biden, the Democratic front-runners for the 2020 nomination have been focusing on social and environmental negatives associated with corporate profit margins. This suggests a stronger move toward higher corporate taxes following the election.

7. We expect stock market returns to be increasingly driven by earnings results. Our analysis shows the biggest return driver for U.S. stocks over the past 18 month has been changes in valuations primarily due to shifting prospects for Fed rate policy. This includes the severe selloff at the end of 2018 over fears of Fed tightening, as well as the sharp rally at the start of this year driven by hopes of Fed easing. With Fed policy turning slightly less dovish, we think investors will again focus on fundamentals, chiefly the prospects for earnings growth.

8. Earnings revisions are likely to remain neutral to negative for some time. While second quarter earnings results have been decent compared to expectations, future revisions have been decidedly negative. The negative-to-positive guidance ratio for the third quarter is currently 5.6, the weakest since the 2015/2016 global slowdown.⁴ Earnings growth is currently expected to be 6% in the fourth quarter and 11% in 2020.⁴ In our view, those numbers can’t possibly be reached absent a U.S./China trade deal and a pickup in global economic growth.

9. We think cyclical market sectors are poised for a comeback. Low volatility, defensive areas of the market have been outperforming economically sensitive cyclical stocks this year, and we think that trend could be poised for a change. This shift would require some combination of a more positively sloped yield curve, a rebound in manufacturing and/or an easing in trade tensions.

10. U.S. equity markets face three key risks: The effects of the trade war; an ongoing slide in earnings estimates; and the Fed being less aggressive about rate cuts than many were hoping.

Equities May Continue Struggling To Make Gains

The past 18 months have been a wild ride for investors, even as both stocks and bonds have delivered solid returns year-to-date. We think conditions will become tougher from here. Stock prices have risen this year despite a rising protectionist trade threat, a slowing global economy, soggy corporate earnings and an uncertain domestic and global political backdrop.

A significant tailwind to stocks this year has been the hope that the Federal Reserve could sustain the expansion by engaging in a series of interest rate cuts. But Chairman Powell’s comments last week were less dovish than many hoped, calling into question whether the Fed could remain stocks’ best friend.

We think stocks and other risk assets are likely to struggle over the coming weeks as investors digest what seems to be a shift in Fed policy and the prospects for new tariffs. Beyond those points, markets will probably be driven by the question of whether the global economy is slowing into recession or is poised to continue expanding. We think the latter is more likely. Prospects for a near-term trade deal are falling, but we still expect a rebound in manufacturing activity in the U.S. as well as in manufacturing dependent economies such as Germany. While investing could become tougher from here, we’re not ready to call the end of the current equity bull market.

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

¹ Source: FactSet, Morningstar Direct and Bloomberg
² Source: Bureau of Labor Statistics
³ Source: Bureau of Economic Analysis
⁴ Source: Wolfe Research