Highlights

• Stocks experienced their best week of 2018 given both the sense that Fed policy may be less tight than expected and signs of progress on the trade front.

• We would caution, however, that trade issues represent a serious potential risk to the global economy and financial markets.

• Volatility may remain relatively elevated, but we think investor sentiment should continue to improve modestly.

Global equities moved higher last week with at least a temporary easing of several key risks. Federal Reserve Chair Powell’s comments on Wednesday that Fed policy was approaching neutral sparked a strong equity rally, while signs of some easing on the trade front also contributed to investor sentiment. The S&P 500 Index experienced its best week of 2018, rising close to 5 percent with all sectors in positive territory.¹ In other markets, investor attention focused on oil, which dipped to its lowest level since 2017, experiencing its worst monthly decline in 10 years.¹

Weekly Top Themes

1. Key changes in perception, rather than actual data, sparked last week’s rally. Almost half of last week’s jump in U.S. stocks came on Wednesday in response to the Fed’s statement about the fed funds rate being close to neutral.¹ Fed Chair Powell’s comments about a lack of visible financial market bubbles also contributed to the markets’ positive tone. Additionally, expectations that the U.S. and China would agree to delay tariffs (which occurred over the weekend) provided a boost.

2. The Fed’s comments were positive for stocks, but Fed policy is likely to continue on a modest tightening bias. Remember, only two months ago Powell said rates were a long way from neutral. The bottom line seems to be that the Fed will remain data dependent as it determines monetary policy.

3. Despite some near-term positives, trade issues remain a risk. While the U.S. and China’s agreement to continue negotiations and delay tariffs is a positive for risk assets. But we’ve seen quick changes in the trade trajectory before.

4. U.S. growth should slow in 2019, but we expect it will remain above trend. Real gross domestic product growth is on track to be close to 3 percent in 2018.² We expect that level to slow to between 2 percent and 2.5 percent in 2019, which would still be decent, especially considering the length of this current expansion.

5. Corporate earnings expectations for 2019 may be too high. Current consensus expectations are for revenues to grow 5 percent and earnings 10 percent.³ We think those numbers are too high and anticipate earnings growth of around 6 percent at best.

We See More Upside Price Potential For Stocks Than Bonds

Two months ago, the financial market backdrop darkened considerably. Worries about economic growth mounted, the Fed indicated that rates may climb more than expected, bond yields rose with the 10-year Treasury yield hitting 3.25 percent and the U.S./ China trade dispute threatened to escalate into an all-out trade war.¹ Geopolitical risks also rose with Brexit looking messier and the budget fight between Italy and the EU worsening. These issues caused global equity markets to sink, with most regions experiencing double-digit price declines. Oil prices also plummeted, which further impaired fixed income credit markets.

We have seen these sorts of downturns occur before in the current bull market. Market weakness was pronounced in 2015, followed by a strong risk-on phase in 2016 and 2017. History is an imperfect guide, but we wouldn’t be surprised to see somewhat better sentiment in the months ahead and at least a modest rebound in risk assets. Still, any sustained climb would require better economic data from outside the United States and/or more progress on the trade front.

Over the near term, we expect markets to remain relatively volatile, but we see some silver linings. For one, equity valuations are more attractive now thanks to a combination of lower prices and positive earnings. Secondly, the market turmoil has helped put at least a temporary cap on bond yields.

Over the longer-term, we think bond markets will remain subject to downward price pressures, as a number of factors are conspiring to push yields higher. For stocks, we think the economic and earnings growth environment will be tougher next year, but should be sufficient to provide some tailwinds. Additionally, there is now a lower bar for positive earnings surprises, which could provide room for valuation multiples to expand.

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

1 Source: Bloomberg, FactSet and Morningstar Direct
2 Source: Bureau of Economic Analysis
3 Source: ISI Evercore Research