9. Equities could come under pressure if interest rates rise. Given that earnings expectations have fallen this year, the increase in stock prices can be attributed to valuation multiple expansions. Given that stocks are a long-duration asset class, a bond market selloff and corresponding rise in rates would negatively affect stocks, which appear fully valued.
10. We think stocks are likely to outperform bonds over the next 12 months. Both asset classes have done well this year with a recovering economy, improving future earnings prospects and low interest rates. Both asset classes also look fully valued, but we think bonds are more overvalued than stocks.
Economic And Political Risks Could Drag On Stocks
The economy is still recovering, but evidence is mounting that renewed lockdowns are slowing the rate of recovery. Stock markets have been pricing in an aggressive rebound in corporate profits, which will be tough to achieve if economic growth falters. Investors also appear to be banking on a coronavirus vaccine or medical breakthrough that would allow the economy to get back on track more quickly. But even with better news on the coronavirus treatment front, the economy will struggle to get back to pre-pandemic conditions since many sectors have been severely damaged. As such, we think stocks have already priced in what looks like a best-case scenario, meaning markets could be subject to negative surprises.
The policy backdrop could also create some headwinds for stocks. Monetary policy could still provide some market support (especially given the Fed’s revised inflation targeting), but future stimulus must increasingly come from the fiscal side. And fiscal policy is slower acting and harder to launch, especially given current massive deficits and debt levels. Related, the political backdrop itself is highly uncertain during this unusually contentious election season. And those risks could escalate if we have an uncertain or contested result in November.
There are, of course, positives to consider as well. Economic conditions are improving and monetary policy support remains open-ended. At the same time, a lack of appealing alternatives has caused investors to continue investing in equities. However, there is ample room for disappointment and we think the next few months will be a risky environment for stocks. As such, we suggest investors continue to approach the markets with caution.
Robert C. Doll is senior portfolio manager and chief equity strategist at Nuveen.
1 Source: Bloomberg, Morningstar and FactSet
2 Source: Labor Department