5. Investor sentiment has improved dramatically over the past month. One month ago, markets were roiled by a surge in wages, worries about rising bond yields and geopolitical uncertainties. While those fears haven’t vanished, investors have been remarkably sanguine in reaction to last week’s economic data and political news.
Rising Inflation, Monetary Tightening And Higher Bond Yields Could Spell Trouble For Stocks
Overall, we are retaining a constructive view toward the global economy. Global growth is solid and trade levels are increasing. At the same time, monetary policy remains broadly accommodative: the G7 monetary policy rate is less than 1 percent while G7 nominal GDP is slightly more than 4 percent.5 Additionally, headline and core inflation readings in developed markets remain low. This looks like a recipe for solid performance from equities and other risk assets.
Nevertheless, we are focusing increasingly on prospects for higher volatility and potential headwinds. We expect stock prices will remain volatile given ongoing uncertainty about inflation, the interest rate outlook, bond yields and political issues such as mounting U.S. protectionism. We also think global growth momentum should begin to moderate as monetary conditions slowly become less accommodative. And while inflation remains low, we continue to see signs that core inflation is moving higher in the United States and most other major economies.
Both bond yields and inflation appear in the early stages of important inflection points. After falling for over three decades, global bond yields have started moving unevenly higher. Real yields are still extremely low, global growth is solid and monetary policy is slowly tightening. Together, these factors mean that bond yields should likely rise over the coming months and years. The inflation outlook is less clear, but we believe inflation is also moving higher as global economic growth accelerates and broadens. We are not expecting sudden and dramatic increases in inflation, but with labor markets tightening, it is reasonable to be on the watch for inflation risks.
A combination of moderating economic growth, tighter monetary policy, higher bond yields and rising inflation presents dangers for equities and other risk assets. And rising political risks certainly don’t help matters. As we saw last month, equities remain vulnerable to a correction and we believe bond markets will be negatively affected by rising yields.
It is too early to suggest that this equity bull market is nearing an end, but we do caution that gains may be tougher to come by, pointing to the importance of investment selectivity.
Robert C. Doll, CFA, is senior portfolio manager and chief equity strategist at Nuveen Asset Management.
1 Source: Morningstar Direct, Bloomberg and FactSet.
2 Source: Labor Department
3 Source: Institute for Supply Management
4 Source: Cornerstone Macro
5 Source: MRB Research