Investors last week continued to focus on the same risks that drove equity prices sharply lower the prior week: trade war concerns, worries about the selloff in tech stocks, moderating economic growth, monetary policy tightening and political turmoil in the U.S. and abroad. It was an up-and-down week for the markets, but stocks finished higher, helped in large part by a strong rebound on Monday.¹ The S&P 500 Index rose 2.1 percent, while Treasury markets were stronger: The yield on the 30-year Treasury dropped below 3 percent as the yield curve flattened.¹

Highlights

• Equity markets regained their footing last week as the recent correction appears to have been less negative than the one in early February.

• It looks to us like the reasons to be optimistic and the reasons to be cautious are roughly balanced.         

• But we also think that positive economic and corporate fundamentals should eventually provide tailwinds for stocks.

Weekly Top Themes

1. The consumer sector of the U.S. economy has been benefiting from tax reform. Confidence levels are higher, household net worth is improving, the labor market remains strong and wages are slowly rising. The March University of Michigan Sentiment Index reached its highest level since 2004, while the Current Conditions Index hit an all-time high.²

2. Capital expenditure levels are starting to pick up, a trend we expect will continue into 2019. Corporate tax cuts have had a positive effect, as have the weaker dollar, still-narrow corporate credit spreads and rising energy prices. Rising protectionism, however, represents a risk to higher cap ex levels.

3. While investors are focused on political downsides to the economy, there are also positives. In particular, we think investors may be overestimating the negative effects of increased trade tensions, but underestimating the positive effects of stimulative fiscal policy.

4. We think large technology companies should be able to manage the risks associated with consumer privacy issues. Companies like Facebook are facing significant public relations problems, but we think the odds are low that serious regulatory and/or legal risks will disrupt their enterprises.

5. We appear to be past the worst of the current market volatility. Compared to the sharp market downturn in early February, the selloff two weeks ago featured less negative market technicals. Volatility levels were lower, trading volume was less and fewer stocks hit new 52-week lows.1 We believe all of this means that the worst of the correction may be in the rearview mirror.

6. Equity valuations are nearly full, meaning future price appreciation may need to rely on stronger earnings. At the same time, tightening monetary policy is likely to put upward pressure on market volatility. The implication is that the sort of smooth upward ride that investors enjoyed throughout 2017 has come to an end. The good news is that we do think corporate earnings can continue to improve.

We See Reasons For Pessimism, But Fundamental Conditions Remain Solid

With markets in the same broad trading range they have been in for the last couple of months, it seems a good time to highlight reasons to be optimistic and competing reasons to be cautious:³

Reasons For Optimism

1) The economic backdrop remains solid.
2) Monetary policy is not yet restrictive.
3) Earnings have been strong and first quarter results look promising.
4) Trade issues are more about rhetoric than reality.
5) Tech company issues are so far more about public relations than fundamentals.
6) Geopolitical risks have been isolated and contained.
7) The Mueller investigation has yet to uncover a smoking gun.

In contrast, our list of negatives are, in many cases, the opposites of the above.

Reasons To Be Cautious

1) Economic growth rates could peak as inflation firms.
2) Central banks could tighten faster than expected.
3) Trade rhetoric could lead to a trade war.
4) Tech sector problems could trigger regulatory risks.
5) Increased government scrutiny could stifle M&A activity.
6) Geopolitical tensions always have the potential to escalate.
7) President Trump could trigger a Constitutional crisis by ending the Mueller investigation.

Although the positives and negatives appear roughly balanced, we are encouraged by the fact that macro fundamentals remain solid even as market volatility has increased. Investors have been rattled by a number of risks, but the overall state of the economy is still good. The consumer sector is strong, corporate profits are growing, capital expenditures are increasing, monetary policy remains broadly accommodative and inflation remains contained.

Over time, we expect markets will return to a focus on these fundamentals, which should provide tailwinds for equity prices. We are keeping a close eye on first quarter earnings results, which could provide a catalyst for a stronger equity environment.

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

1 Source: Morningstar Direct, Bloomberg and FactSet.
2 Source: University of Michigan
3 Source: Adapted from J.P. Morgan Research, Bull / Bear Debate, March 30, 2018.