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