Key Points
• As long as global economic growth improves modestly, we expect corporate earnings can climb.
• Markets have been exhibiting changes in leadership beneath the surface, and we expect these trends to persist in the coming months.
These are confusing times for investors. Global equity markets have been churning over the last couple of months while exhibiting leadership changes beneath the surface. The recent increase in government bond yields has hurt bond proxies and defensive sectors but helped the financial sector.1
Technology stocks have sagged, but prospects appear bright for some tech areas.1 Weak oil prices have hurt energy companies, while some health care industries have rallied.1 Looking ahead, we think improving corporate earnings are the key ingredient needed to sustain the equity bull market. And with economic growth prospects looking solid, we think earnings can climb.
Weekly Top Themes
1. The strong jobs market points to continued good growth. The higher-than-expected 220,000 new jobs created in June is a good sign.2 Wage growth, however, remains disappointing, with the annualized growth rate at only 2.5%.2
2. Institute for Supply Management readings point to stronger growth. The ISM manufacturing and nonmanufacturing indices recently hit three- and two-year highs, respectively, leading us to believe that U.S. real gross domestic product growth could approach 3% for the second quarter.3
3. We expect the global economy to accelerate slowly. The current Goldilocks scenario of low inflation and slow growth should allow the current long expansion to continue, even as the rate of growth remains slower than average expansions.
4. Nevertheless, we are seeing some financial excesses. Economic expansions typically produce excesses that bear watching. Cornerstone Macro identified six: 1) high real unit labor costs, 2) high house prices, 3) high auto debt levels, 4) high commercial real estate prices, 5) too much corporate debt, and 6) excessive profit dispersion.4
5. The political backdrop also looks uncertain. Congress returns to work this week to resume work on health care reform. This issue is important in its own right, but will also influence tax reform discussions set for later this year. Republicans are far behind schedule, and failure to make progress may eventually jeopardize their prospects for the 2018 mid-term elections.
6. The outlook for corporate earnings is strong. Consensus expectations for year-over-year earnings-per-share growth is 8% for the second quarter and 11% for the full year.5 BCA Research is forecasting EPS growth could hit 18% on a four-quarter moving basis later this year before moderating in 2018.5
7. Downward pressure on oil prices is likely to persist. Supply is too high as production levels remain elevated. And demand is soft thanks to slow global economic growth, increased efficiency and rising use of alternative fuel sources.
8. Equity market technicals point to internal leadership changes. Strategas Research made the following observations: 1) The combined weight of the largest 10 stocks in the S&P 500 Index is only 19%, lower than the long-term average of 20% and significantly below the 27% peak reached in 1999. 2) On an equally-weighted basis, health care is the leading sector while technology is in second place. 3) The energy sector has given up all of its 2016 outperformance and sits at a relative low versus the broader market.
9. Select non-U.S. equity markets are taking over a leadership position from U.S. stocks. Relative valuations have long been more favorable for international equities, and a broadening economic expansion and revival in global trade could be the necessary catalysts to drive this leadership shift.
10. We also expect leadership changes within U.S. stocks will continue. We expect U.S. stocks to remain range-bound with a bias to the upside. At the same time, improving economic growth and a more hawkish Federal Reserve appear to be causing the financials, industrials and select health care areas to take the leadership baton from utilities and consumer staples. We also believe select areas of the technology sector look attractive.
Bob Doll is chief equity strategist at Nuveen Asset Management.
1 Source: Morningstar Direct, as of 7/7/17
2 Source: Bureau of Labor Statistics
3 Source: Institute for Supply Managemrnt
4 Source: Conerstone Macro Research, 6/29/17
5 Source: BCA Research, 7/3/17
6 Source: Strategas Research, 6/21/17