Highlights

• Italian political uncertainty drove market volatility higher last week, but events calmed by Friday.                     

• U.S. economic growth appears to be accelerating, although growth may be slowing elsewhere in the world.                   

• We think trade and geopolitical risks need to diminish before stock prices can break through their trading ranges.

Equity markets were highly volatile last week, especially early in the week when Italian political turmoil dominated the financial headlines. Trade risks also resurfaced last week as investor uncertainty rose in light of President Trump’s surprising shifts in trade policy. Nevertheless, equity markets made gains, with the S&P 500 Index climbing 0.5 percent.¹ Energy and technology were the best-performing sectors, while financials and industrials lagged.¹ Treasury markets were also volatile, but wound up being largely unchanged.¹

Weekly Top Themes

1. Despite initial fears of catastrophe, Italian political turmoil appears largely contained. Events came to a head early last week when Italian President Sergio Mattarella rejected economist Paolo Savona to be the finance minister in the coalition government. This brought the stability of the entire Italian government into question, with some worrying about a possible Italian exit from the eurozone. It appeared as if Italy would be in for a long period of uncertainty, but the 5-Star Movement and League political parties established a coalition government that was sworn in on Friday.

2. Trade tensions again flared after earlier signs of thawing. The Trump administration unexpectedly announced the United States would move forward with investment restrictions and tariffs on Chinese goods, and stated it would impose tariffs on steel and aluminum imports from the EU, Canada and Mexico. Clearly, trade restrictions remain an economic and financial market wildcard.

3. The May jobs report provides evidence that U.S. economic growth is accelerating. The data was strong across the board: A better-than-expected 223,000 new jobs were created last month while the unemployment rate dropped to 3.75 percent, its lowest level since December 1969.² Wages also rose, with average hourly earnings increasing at 2.7 percent year over year.²

4. Strong consumer spending also points to improving second quarter growth. Real spending levels in April showed an advance, while March’s numbers were revised higher.³ We think real consumer spending could climb as much as 3.5 percent in the second quarter, which could push gross domestic product growth up to the 3 percent level.

5. Non-U.S. growth, however, appears to be decelerating. The Index of Leading Economic Indicators is gaining strength in the United States, but appears to be slowing in most of the rest of the developed world.⁴

Improving economic growth should favor cyclical market sectors

Markets have continued to churn in recent months and remain range bound, but the corporate earnings picture has been stellar. While much attention has been focused on the positive effects from corporate tax cuts, revenues have also been advancing strongly. The year-over-year revenue growth rate topped 8 percent in the first quarter. We expect corporate earnings growth to moderate later this year or early next year, but strong corporate earnings should remain as an important tailwind for stock prices as long as the global economic expansion continues.

At the same time, however, a number of risks are holding markets back. These include renewed concerns about growing trade protectionism that manifested last week, as well as the sort of political uncertainty from Italy that dominated last week’s headlines. The on-again-off-again summit between the United States and North Korea also looms large and has been contributing to market volatility. From a more fundamental economic perspective, investors are worried about rising interest rates and inflation, Federal Reserve policy and signs that global growth might be decelerating.

Over the near term, we expect markets to remain in their current churning phase as investors digest these broad macro risks. We believe investor confidence should regain traction in the months ahead, and expect an important inflection point could occur if and when global economic indicators bottom and start to pick back up.

As a result, we believe equities will eventually break out of their trading ranges to the upside and expect stock markets will enjoy another sustained advance. Cyclical market sectors have been generally outperforming defensive areas. Defensive sectors could experience a near-term catch-up phase. But given our view that the global economic expansion still has legs, we think it makes sense for investors to stick with a pro-growth stance that favors cyclicals over defensives.

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

1 Source: Morningstar Direct, Bloomberg and FactSet
2 Source: Source: Bureau of Labor Statistics
3 Source: Comerce Department
4 Source: Conference Board