Highlights

• Equity markets remain stuck between the positives of improving economic growth and strong corporate earnings and the negatives of rising trade issues.

• We are growing more concerned about protectionism, but still expect tensions to ease.

• Over the next 6 to 12 months, we believe stock prices will move unevenly higher and government bond markets will struggle.

Investors focused on a mix of positive and negative developments last week. On the plus side, second quarter corporate earnings have been coming in strong. However, trade worries continued to dominate the investment narrative and concerns grew over additional interest rate hikes. U.S. equities were largely unchanged for the week, which is not surprising in this environment.¹ Financials and industrials exhibited strong performance, with energy being the largest decliner.¹ U.S. Treasury prices fell last week, while the yield curve steepened slightly.¹

Weekly Top Themes

1. Aided by tax law changes, corporate earnings have been coming in strong. With 24 percent of S&P 500 companies reporting, results have beaten estimates by an average of 4.4 percent.² 78 percent of reporting companies have surpassed bottom-line expectations.² At this point, estimates for growth in second quarter revenues, earnings and earnings-per-share stand at 8 percent, 19 percent and 21 percent, respectively.²

2. Strong earnings results are coming more from revenue gains than bottom-line margins. Since 2010, 90 percent of positive earnings surprises have come from margins.² This quarter, 75 percent of surprises are from better revenues.² This is a healthy sign for future earnings results, and hence for stock prices.

3. The Federal Reserve appears likely to continue raising interest rates, but is acknowledging downside risks. In his congressional testimony, Fed Chair Powell noted improving labor market conditions and rising inflation. He also pointed out, however, that rising trade problems may be weighing on capital expenditure levels and could cause broader economic problems.

4. The long-term U.S. fiscal outlook is growing more troublesome. The combination of tax cuts and more federal spending is likely to cause long-term problems. Over the next 5 to 10 years, interest costs are likely to rise and government bond yields should move higher as investors demand a higher premium given soaring debt levels. Over the longer-term, taxes will likely need to rise to service government debt and capital spending may fall, both of which could undermine economic growth potential. Additionally, the dollar is likely to weaken, which would make imports more expensive.

5. Equities are likely to remain in their current trading range. Prices have been grinding higher in recent weeks, but we don’t anticipate a decisive breakout to the upside before trade tensions calm and global economic growth momentum bottoms. Until then, we expect strong corporate earnings will keep prices from falling.

Despite Rising Risks, We Think It Is Too Early To Take A Defensive Investment Stance

Rising trade tensions, new tariffs and protectionist threats are threatening the upside potential of both stock prices and bond yields. Were it not for these risks, we think equity markets would likely have moved higher this year and government bonds would be under more pressure.

Even more than the actual negative economic impact, the uncertainty over trade policy is worrying investors. It is increasingly uncertain if President Trump actually wants a full-fledged trade war that will allow him to claim some sort of political victory. If so, the global economy could be dragged into a slowdown or recession. While logic would suggest that no one actually desires a trade war, cooler heads have not been prevailing and risks are rising. Our best guess is that tensions will eventually ease, but our concerns are growing.

So far, financial markets have remained fairly solid in the face of these pressures. Corporate earnings are helping stocks prices and bond yields have remained relatively low even as economic growth improves, inflation rises and the Fed remains committed to additional rate hikes.

How does this affect our investment outlook? We maintain a mostly optimistic view toward equities and other risk assets, but admit to having less conviction than normal in this belief. Over the next 6 to 12 months, we are forecasting modest equity gains and further erosion in government bond market returns. We see few signs that the current economic expansion is ending, despite trade risks, a possible slowdown in capital expenditure spending and some weakening of economic growth in some areas of the world. As such, we think it would be premature to adopt a more defensive investment stance.

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

 

1 Source: Morningstar Direct, Bloomberg and FactSet

2 Source: Credit Suisse