Highlights

• Investors focused on the positives last week (particularly a strong February employment report) and bid stock prices higher.

• Markets did not react negatively to last week’s tariff announcements, but we see more downside than upside.

• Over the long-term, we are growing more concerned about what rising bond yields, tighter monetary policy and higher inflation could mean for stocks.

President Trump’s proposed trade tariffs dominated most of the financial headlines last week, but investors looked past the negatives to bid up stock prices. The S&P 500 Index rose 3.6 percent last week.¹ Half of that gain came on Friday, following a strong labor market report that showed jobs increases but stable wages.¹ For the week, industrials, financials, technology and materials were all up over 4 percent, while utilities lagged.¹ Treasury yields also rose last week in the face of stronger economic data.¹

Weekly Top Themes

1. Higher tariffs could potentially damage economic growth. Donald Trump’s proclamation of a 25 percent tariff on imported steel and a 10 percent tariff on aluminum contributed to political uncertainty. It drew sharp criticism from Republican leaders in Congress, played a role in Gary Cohn’s departure from the White House and raised the possibility of retaliatory action from other countries. We believe such tariffs are effectively taxes that can drive a wedge between producers and consumers, and are more likely to hurt economic growth and jobs creation than they are to help.

2. February’s jobs report points to economic acceleration. Payrolls growth showed an increase of 313,000 jobs, the highest level since June 2016.² In addition, the overall labor force grew by 806,000, which kept unemployment at 4.1 percent and wage growth low at 2.6 percent year over year.² On balance, the data showed that labor supply is currently keeping pace with labor demand, which should contribute to economic growth without causing significant price pressures.

3. Manufacturing data also pointed to solid growth levels. The Institute for Supply Management’s manufacturing index hit its highest level since 2004, while the nonmanufacturing index also surprised to the upside.³

4. A more competitive U.S. economy should help narrow a growing trade gap. The U.S. energy renaissance, narrower wage disparity between the U.S. and China and the effects of U.S. corporate tax reform should all help make the U.S. economy more dynamic and competitive.⁴ This, in turn, could help narrow the U.S. trade deficit as a percentage of U.S. gross domestic product.⁴

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