Highlights

• Earnings growth may be peaking with the strong first quarter results, but that does not mean the equity bull market is coming to an end.

• Volatility is likely to remain elevated as sentiment shifts between a focus on the positives and negatives.

• It may take time, but we think stocks will chart new record highs before this current economic cycle ends.

Corporate earnings were in focus for much of last week. Results continued to come in stronger than expected and earnings are on track for their best quarter since 2010.¹ But concerns remain that earnings growth may have peaked in the current cycle. Investors also focused on economic data, including another drop in U.S. unemployment and indications that global growth momentum may be slowing. Amid these crosscurrents, stocks were mixed, with the S&P 500 Index dropping 0.2 percent for the week.² Technology was a standout performer, while telecommunications and health care lagged.²

Weekly Top Themes

1. The labor market continues to tighten. April’s headline payroll gain of 164,000 jobs was a bit weaker than expected, but unemployment fell to 3.9 percent, its lowest level since 2000.³ Average hourly earnings rose 0.1 percent, putting the year-over-year growth rate at 2.6 percent.³

2. First quarter earnings results continue to impress, helped by tax cuts. With 85 percent of companies reporting, earnings are ahead of expectations by an average of 7.3 percent.¹ Earnings-per-share growth is on track for 25 percent.¹ Were it not for the effects of tax cuts, that number would be only 18 percent.¹

3. Even if earnings are peaking, that does not necessarily mean the equity bull market is ending. According to one study, since the 1950s, a cyclical peak in earnings growth has tended to be followed by stock prices moving higher: From a peak in earnings-per share growth, stock prices were still higher six months later 74 percent of the time and were higher 12 months later 68 percent of the time.⁴

4. Inflation should continue to rise slowly. Core CPI inflation is now close to the Fed’s two percent target after rising 50 basis points over the last six months.⁵ The current pace of economic growth implies inflation is likely to continue trending higher over the next year, although likely at a slower pace.

5. Headline trade risks have receded, but remain a potential issue. The recent U.S./China trade talks appeared to be generally cordial, but we have not seen any measurable progress. We think trade risks are likely to remain a consideration for markets for quite some time.

Upside And Downside Risks May Result In Ongoing Volatility

We do not believe that we are close to the end of the current cycle of global economic expansion, but the endgame may develop more quickly than many investors expect. At this point, it appears that upside and downside risks for the economy and financial markets may be pretty well balanced. We offer the following list of reasons for optimism and reasons to be cautious, adapted from J.P. Morgan Research:⁶

Reasons To Be Optimistic

1) First quarter earnings are very strong.

2) Equity valuations are reasonable.

3) Corporate America is flush with cash.

4) U.S. growth momentum may be plateauing, but is not slowing.

5) Trade restrictions have not been as severe as feared.

6) Global monetary policy remains accommodative.

7) North Korea risks have eased.

Reasons To Be Cautious

1) Margin pressures could hurt future earnings.

2) Higher rates could represent a headwind for valuations.

3) Political risks may rise as the midterm elections approach.

4) Global growth may start to slow in the coming years.

5) Trade policy remains a long-term risk.

6) Investors may be too complacent about monetary tightening.

7) President Trump’s legal issues could escalate.

We expect stock prices will break new ground, but maybe not for some time.

Overall, we remain broadly constructive about the long-term outlook for stocks given economic and earnings momentum, and expect equities will continue to outperform bonds over the coming year. Over the near-term, however, we expect markets will remain stuck in the same broad trading range they have been in since early February as sentiment moves between concerns about slowing growth and rising inflation to optimism about earnings. We think stocks will again break new ground and push higher, but it may yet be several months or longer before that happens.

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

 

1 Source: Credit Suisse

2 Source: Morningstar Direct, Bloomberg and FactSet

3 Source: Bureau of Labor Statistics

4 Source: BMO Capital Markets

5 Source: Labor Department

6 Source: J.P. Morgan Research, Bull/Bear Debate, 4 May 2018