5. Interest rates must be noticeably higher to slow the pace of equities. We don’t think the stock market will slow until rates are high enough to slow the overall economy. A 10-year Treasury yield in a range of 3.75 percent to 4.25 percent would be cause for concern.
Reasons For Optimism And Caution
Currently, we offer reasons to be both optimistic and cautions, as adapted from J.P. Morgan Research.3
Reasons For Optimism
1. U.S. economic growth remains solid despite trade headwinds and higher rates.
2. Corporate fundamentals are still very healthy.
3. Valuations aren’t too high.
4. Trade tensions haven’t detracted from economic growth.
5. The net supply for stocks continues to shrink, creating a favorable tailwind for prices.
6. Lowered tax rates should insulate the market from potential fallout from November elections.
7. Dramatic political changes may not occur in November’s U.S. election.
Reasons For Caution
1. Growth outside the U.S. is mixed.
2. The U.S.-China relationship is getting worse.
3. Companies are increasingly concerned about the effects of the trade tariffs.
4. Business leaders continue to face cost pressures.
5. Modest rises in interest rates and inflation could continue to weigh on valuations.
6. Central banks are beginning to tighten interest rates.
7. Global political issues continue to exist, particularly regarding Italy, Germany, Brexit and U.S. midterm elections.
The Equities Backdrop Remains Positive
Corporate fundamentals remain strong, but the upcoming third quarter earnings season may reveal future problems. Bullish investors are targeting earnings of around $178 per share with a price-earnings ratio (P/E) of 17 in 2019.1 These earnings and P/E assumptions leave little room for error.
Overall, equities do not face enormous downside potential, and we think a focus on cyclicals and emerging markets may offer better risk-return potential.
Robert C. Doll is senior portfolio manager and chief equity strategist at Nuveen Asset Management.
1 Source: Morningstar Direct, Bloomberg and FactSet
2 Source: Federal Reserve
3 Source: J.P. Morgan Bull/Bear Debate, September 26, 2018