Key Points

• Republicans’ setback in passing health care reform could signal trouble for tax cuts and infrastructure spending plans.
• Optimism over pro-growth legislation may fade, but the U.S. economy remains solid.
• We think stocks may be poised for a correction, but we still support a pro-growth investment stance.

Stocks experienced their largest one-week decline since the election, as the S&P 500 Index fell 1.4%.1 Most losses occurred on Tuesday when it became clear that the Republican health care plan was facing trouble,1 signaling that President Trump’s pro-growth economic agenda could falter. Small cap stocks, financials and industrials fared the worst last week, with utilities and REITs gaining ground.1 Treasury prices rallied for a second straight week, while the U.S. dollar fell for the third week.1

Weekly Top Themes

1. The GOP’s health care setback could signal additional political problems. From a political perspective, we think the key issue is whether the president will encounter similar problems with his tax reform agenda, which is likely to be as complicated as health care reform, if not more so. We think some sort of tax bill will be passed. If political turmoil is ongoing, higher risk, cyclical areas of the equity market would likely remain under pressure.

2. Additionally, possible infrastructure spending may be less comprehensive than expected. While the president has talked a lot about additional spending, he has yet to put forward any specific plans. At the same time, most Republicans appear disinclined to support more infrastructure initiatives without spending offsets. We think investors are too optimistic about prospects for additional spending measures and may wind up being disappointed.

3. Internal market dynamics suggest we may be at the forefront of a broader correction. Global risk assets, including equities, have remained quite resilient in recent months, but we have seen underlying changes. Higher-risk areas such as small caps, cyclical sectors and some fixed income credit sectors have been flagging,1 which could be a precursor to a broader risk asset selloff.

4. Additionally, we may see a leadership transition from U.S. to non-U.S. equity markets. U.S. stocks have outperformed their international counterparts for years,1 but that trend may be changing. As non-U.S. economic and earnings growth improves, the leadership baton may be passing to other markets.

We May See a Correction, but This Bull Market Isn’t Over

U.S. stock prices rose significantly over the past year and experienced a strong bounce after the election. We have been saying for some time that economic and political optimism may be overdone. It appears investors are finally starting to question the extent to which President Trump can deliver on his wide range of pro-growth economic promises. Last week’s stunning setback for health care reform shows he will have difficulty pushing his agenda forward. Any
politically-oriented economic boost over the next 6 to 12 months may be less robust than expected.

Nevertheless, we remain relatively upbeat about the state of the U.S. economy. Growth trends and sentiment began improving last summer. We believe fundamentals remain solid, including the labor market, manufacturing, housing, consumer spending and business investment. Even if sentiment drops a notch or two due to fading political optimism, we expect economic growth will remain on track.

However, we think equity markets may have gotten ahead of themselves, and risk assets appear poised for a correction. The good news is that investor sentiment appears to have improved over the last year. Investors are unlikely to overreact to negative news as they did periodically throughout 2016.

We don’t believe the recent peak in equity prices marks the high point for this bull market, but more volatility is likely as the post-election euphoria continues to fade. As such, we suggest that investors ride out any near-term equity turbulence. At the same time, we think government bonds look expensive and do not believe the recent downturn in yields is likely to continue. We are maintaining our moderate pro-growth investment view and continue to believe equities will outperform bonds over the next year.

Bob Doll is chief equity strategist at Nuveen Asset Management.

1 Source: Morningstar Direct and Bloomberg, as of 3/24/17