Highlights

• Markets continue to rally as the fears that caused the 2018 correction continue to fade.

• We expect volatility to persist and wouldn’t be surprised to see a near-term pullback.

• But we also remain constructive and suggest investors approach the market selectively and tactically.

The equity market rally that began at the end of December continued last week, with U.S. stocks rising 2.6 percent, as measured by the S&P 500 Index.¹ Energy led the way, thanks to a 5 percent jump in oil prices.¹ Defensive areas of the market underperformed, although the utilities sector was the only one to actually lose ground.¹ Despite many near- and long-term risks, investor attitude toward the big risks that drove stock prices lower in the fourth quarter (trade issues, recession fears and worries over Fed policy) have turned remarkably. We have a generally constructive view toward stocks, but think markets may be due for a pullback.

Weekly Top Themes 

1. Consumer and business confidence should improve over the coming months. Many sentiment measures have declined amid the turmoil in Washington and volatile financial markets. With the risk of another shutdown averted and better news on the trade front, we think sentiment should rise.

2. Tightening lending standards could create additional downside growth risk. Should this trend start to cause capital expenditure growth to drag, we would see reasons for worry. So far, business confidence suggests capex spending will remain OK.

3. U.S. China trade negotiations are moving in a positive direction, but risks remain. We think we’ll see a modest agreement in the coming weeks, or at least an agreement to delay the March 1 deadline and keep talking. But key issues such as intellectual property rights are likely to remain unresolved, meaning trade issues aren’t going away any time soon.

4. Fourth quarter economic growth may have been worse than previously expected. A sharp drop in December retail sales has caused many economists to lower their forecasts for growth, suggesting the economy entered 2019 with less momentum than anticipated.

5. The pace of jobs growth may also be slowing. Last week’s rise in unemployment claims could mean that jobs growth is plateauing.

6. Rising debt issues are a concern, but fundamentals still look decent. The overall debt profile of the U.S. government is worsening, which could present significant economic issues over time. But household and corporate debt levels are healthy, and we don’t think we are entering an environment of serious credit issues.

7. The risks that caused the fourth quarter market selloff may have faded, but other issues remain. A long list of issues could trip up markets this spring, including Brexit, reemerging trade disputes, political uncertainty in the run-up to the 2020 election and the Mueller investigation. But we don’t expect these issues to cause the same worries that drove markets lower at the end of 2018.

A Near-Term Pullback Is Possible, But We Suggest Sticking With A Moderate Pro-Growth Stance

Stocks have advanced since the end of last year on the back of increased optimism over trade issues, mostly solid economic data and less-worse-than-expected corporate earnings results. The dramatic shift toward dovishness in Federal Reserve rhetoric has also helped. But economic data has softened a bit over the last couple of weeks. The key question now is whether this is due to temporary factors, such as the government shutdown or Brexit uncertainty, or if it reflects a fundamental downshift from the fading effects of corporate tax cuts, debt issues or a delayed impact from Fed rate hikes.

The answer to that question will probably determine the direction of the stock market in 2019. Over the near term, we think prices may have come too far, too fast, meaning markets could be due for a consolidation or pullback. But even if that were to happen, we doubt markets would retest their December lows. We expect markets will be volatile this year, but continued slow growth in the economy and corporate earnings should boost stock prices higher by year end.

As such, we think it makes sense for investors to stick with a moderately pro-growth stance. At the same time, we think investors may want to be selective and tactical—focusing on higher-quality companies, while selling into strength and buying into weakness.

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

 

1. Source: FactSet, Morningstar Direct and Bloomberg