Highlights

• The sharp selloff in the Turkish lira should remain relatively contained, meaning we do not expect contagion to spill over into the rest of the world.

• Trade issues remain the most critical risk to the global economy, but we do not see this issue causing a recession.

• We expect both stock prices and bond yields to rise over the coming year.

The sharp selloff in the Turkish lira dominated global financial markets last week, while investors also paid attention to signs of economic weakness from China. This created a generally risk-off move in markets. U.S. equities bucked the trend by climbing, thanks in part to hopes of improvement on the trade front. The S&P 500 Index climbed 0.7 percent for the week, with defensive areas and the industrials and financial sectors leading the way.¹ In contrast, commodity-oriented companies, consumer discretionary and technology lagged.¹

Weekly Top Themes

1. Trade issues appear to be improving on the margin, but we expect this issue to linger. President Trump decided last month to seal agreements on NAFTA and with the European Union, likely to gain traction on a harder line with China. Chinese officials are due to travel to the United States for another round of negotiations later this month, but we caution investors not to read this as an overly optimistic sign. We still expect trade issues to surface and perhaps escalate, and see little hope of significantly easing tensions this year.

2. Inflation is likely to continue to slowly climb. As economic growth accelerates, inflation pressures are mounting. We believe prices and wages will continue rising marginally into 2019.

3. Corporate earnings growth is likely to decelerate in the second half of the year. Following an incredibly strong first and second quarter, corporate management teams are indicating the operating environment may grow more difficult. A combination of trade concerns, increased margin pressures, higher commodity prices and rising wages could put downward pressure on earnings.

4. Capital spending continues to strengthen. The second quarter saw another solid rise in spending. Capital expenditures rose 17 percent year-over-year, with the technology sector leading the way.² Although trade concerns have not yet weighed on capex levels, policy uncertainty could negatively affect future planning.

5. Democratic Party prospects for the midterms appear to be improving. We still believe Republicans will keep control of the House of Representatives, but will likely lose the Senate. However, a full Democratic sweep of Congress is increasingly looking like a possibility. Should that happen, we could see a tighter regulatory environment and a rollback of recent tax cuts that could negatively affect equity markets. We also could see more of a push for populist policies such as a higher minimum wage, drug price controls and additional protectionist trade practices.

We Expect Turkish Currency Woes To Remain Contained

The Turkish currency collapse came at a particularly bad time, since emerging market equities and currency markets were already under pressure. The European banking sector has also been struggling, following political tensions in Italy and general worries over the state of the European economy. Although downside risks exist, we do not anticipate seeing anything close to the 1997-1998 Asian currency crisis or a replay of the Greece meltdown from earlier this decade. The damage to investor sentiment, however, has pushed more investors into the relative safety of U.S. equities and is putting more upward pressure on the value of the U.S. dollar. We expect these trends to continue until the global economy demonstrates further resilience, and perhaps until we see more easing in trade tensions.

A Solid Global Economy Should Provide Resilience For Equities

Despite events such as the Turkish currency collapse and ongoing trade issues, the global economy has remained relatively resilient. Signs of localized weakness and trade risks have kept a lid on government bond yields and have prevented central banks from moving too far from accommodative monetary policies. Global equities have been trading mostly sideways for months, ever since the winter spike in government bond yields.

We have, however, seen a widening divergence between the United States and the rest of the world. U.S. stock prices have been flirting with new highs, while most other global markets have been flat to lower.¹ The United States remains in a “risk-on” mode while the rest of the world is seeing worsening sentiment.

We do not expect this divergence to persist for too much longer and believe the forces causing weakening sentiment will eventually dissipate. The global economy is more structurally sound than it was five or 10 years ago (particularly in the United States and Europe). As such, we think the world economy can better withstand periodic and localized setbacks. Trade issues remain a big wildcard. While we see notable risks from rising trade tensions, we do not believe they will spill over into a recession. We think the global economy will more likely continue to accelerate, which should put additional upward pressure on both global equity prices and on global bond yields.

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

 

1 Source: Morningstar Direct, Bloomberg and FactSet
2 Source: Empirical Research Partners