Highlights

• Stock prices have risen 20 percent since their low in late December, to the point where we think they are fairly valued.

• Markets will likely enter a near-term consolidation phase to allow growth expectations to catch up to prices.

• We think markets present long-term opportunities, but it will probably be wise to remain tactical in this environment.

Last week saw mixed economic data, continued progress on the trade front and ongoing domestic and global political uncertainty. Markets were somewhat listless in this environment, with U.S. stocks rising slightly for the week.¹ The biggest winners were technology and financials, while materials and defensive sectors sold off.¹ In general, we think markets are fairly valued and expect the current bull market to persist, but also expect a near-term consolidation.

Weekly Top Themes 

1. Fourth quarter real gross domestic product growth was better than expected. The economy grew 2.6 percent last quarter, with a year-over-year gain of 3.1 percent.² Consumer spending rose for the third consecutive quarter, while capital expenditures also accelerated.²

2. U.S. manufacturing is showing signs of trouble. The Institute for Supply Management Index dropped sharply in February, showing that U.S. manufacturing has been hit by the broader global industrial slowdown.³

3. U.S. economic growth should improve. Evercore ISI offered a list of reasons why:⁴ stocks have bounced back, credit spreads have narrowed, the shutdown is over, unusually cold weather has passed, employment is rising, wage growth is accelerating, household formation is improving, inflation remains tame, monetary policy is accommodative and tax refunds are rising.

4. U.S. economic growth should improve. Evercore ISI offered a list of reasons why:⁴ stocks have bounced back, credit spreads have narrowed, the shutdown is over, unusually cold weather has passed, employment is rising, wage growth is accelerating, household formation is improving, inflation remains tame, monetary policy is accommodative and tax refunds are rising.

5. We think debt ceiling drama is going to rise. The current debt ceiling was reached on March 1, although the Treasury Department has the flexibility to keep the government funded for another six months. Enough deficit hawks in the Republican party will vote against raising the debt ceiling on principal to force President Trump to make a deal with Democrats, which will likely result in additional spending on domestic programs.

6. Stock valuations increased this year, but we think equities remain fairly valued. With earnings expectations falling since late last year and prices increasing, valuations have risen. When the market bottomed on December 24, the S&P 500 forward price-to-earnings ratio declined to 13.5X.¹ It has since risen to around 16.5X, which we think is fair given where we are in the economic cycle.¹

7. Equity prices and growth expectations have not been moving in concert. Prices have risen but growth expectations have not, which means something has to give. Either stock prices will need to fall to match growth expectations and/or economic and earnings growth expectations will need to rise. We think the current market advance is likely to pause for a period of consolidation, allowing expectations to catch up.

Stocks May Soon Enter A Consolidation Phase

U.S. stock prices have risen by 20 percent since late December, thanks to three key tailwinds: better-than- expected (or feared) earnings, an aggressive dovish pivot by the Federal Reserve and reduced trade tensions.¹ During that same time, economic fundamentals have not really shifted much. Growth remains slightly positive, inflation is still tame and interest rates are still generally low.

Together, these factors suggest that stocks have probably risen too much, too quickly over the short term, and we think U.S. stocks may be overbought. We think the bulk of the good news is already baked into market prices, with investors expecting the Fed to remain on hold and believing that trade disputes are fading.

Fundamentals and sentiment are strong enough that we don’t expect the quick and sharp correction that dominated market action late last year. But we do think investors will probably be in profit-taking mode and stocks may enter a consolidation phase in which prices remain in a trading range for a while. Eventually, we think the risk-on phase will reemerge, but that would require government bond markets to remain calm, the geopolitical backdrop to remain stable and global economic growth to firm modestly.

We continue to have a constructive long-term view toward stocks and think prices still have room to rise, but it pays to be tactical in this market. Focusing on companies with solid levels of free cash flow and being willing to buy into weakness and sell into strength seems like a logical approach in 2019.

Robert C. Doll is chief equity strategist and senior portfolio manager for Nuveen.

¹ Source: FactSet, Morningstar Direct and Bloomberg
² Source: Bureau of Economic Analysis
³ Source: Institute for Supply Management
⁴ Source: Evercore ISI