Key Points

• Economic data has trailed off in recent weeks, but we see reasons to expect a renewed acceleration.
• In the near-term, confidence levels could diminish, providing a headwind for stocks.
• Nevertheless, we believe it makes sense to maintain a pro-growth investment stance.

Despite the usual volume of political headlines, markets were relatively quiet last week. U.S. equity prices were little changed, Treasury yields fell slightly amid yield curve flattening, the dollar weakened and oil prices declined for a fourth week.1

Weekly Top Themes

1. The Federal Reserve remains on track to slowly tighten monetary policy. As expected, the Fed hiked the fed funds rate by 25 basis points to 1.0%. Despite persistent inflation weakness, the central bank also indicated that one more increase was likely later this year. The Fed also laid out a plan to slowly normalize its balance sheet.

2. Inflation remains stubbornly low. A 6% decline in gasoline prices in May resulted in a 0.1% decrease in the headline Consumer Price Index.2 Even core inflation (which excludes food and energy) increased only 0.1% last month.2

3. Mixed economic signals suggest confidence could take a hit. In recent months, we have seen increased softness in so-called “hard” economic data, including retail sales, automotive production and employment. At the same time, “soft” data such as business confidence measures point to an expectation of economic acceleration.3 In our experience, these disconnects typically result in a move in the soft data, suggesting confidence measures could be due for a setback. Should this happen, it could provide a headwind for equity prices.

4. We expect economic growth to improve in 2018. U.S. GDP is likely to accelerate by around 2.0% this year. We expect that number to climb near 2.5% in 2018, as we anticipate fiscal stimulus from the Trump Administration and Congress. But downside risks are increasing. At present, we are watching for a possible damaging debt ceiling debate and monitoring uncertainty surrounding tax cuts.

5. Chinese growth continues to be a weak spot for the world economy. Policymakers are still in a tightening mode as authorities attempt to restructure the country, and economic activity looks mixed at best.

Equities Should Continue Their Long-Term Outperformance

Investors have become slightly more pessimistic in recent weeks. U.S. economic data has softened, and currently high consumer and business confidence levels could diminish. This sort of soft patch is nothing new. Over the last decade, we have seen numerous periods of mounting pessimism as the world has remained beset by choppy economic growth, deflation scares and numerous political risks. Given this backdrop and the overhang of the financial crisis and Great Recession, it is not surprising that safe-haven assets have remained in high demand and that global bond yields remain extremely low.

For several years, we have advocated a pro-growth investment stance, suggesting overweight positions in equities make sense. The recent downturn in economic data has not changed our view. At present, the biggest objection to this view is that many investors believe that equities in general, and U.S. equities in particular, are overvalued. While equity valuations are less attractive than several years ago, we still believe stocks are more attractive than bonds and cash. Additionally, we think equity valuations can be sustained or climb further, as long as bond yields remain low and corporate profits rise. From a geographic perspective, it would be reasonable to expect a “catch-up” phase when non-U.S. markets outperform U.S. stocks.

Regarding our investment views, we continue to focus on financial assets that could benefit from a modest acceleration in global economic growth. This leads us to favor non-resource-related areas of the global equity market and to prefer credit sectors over government bonds in fixed income markets. The key to our outlook is that corporate profits must continue to improve. And notwithstanding some recent economic weakness, we believe the global economy should continue to accelerate modestly, providing a tailwind for corporate earnings, profits and equity prices.

Bob Doll is chief equity strategist at Nuveen Asset Management.

1 Source: Morningstar Direct, as of 6/16/17
2 Source: Bureau of Labor Statistics
3 Source: Conference Board