Highlights

• Economic data has improved over the past few months, but global manufacturing and trade levels remain weak.

• Corporate earnings results have been solid for the third quarter. We remain concerned that expectations for next year are too high.

• Value styles have been outperforming growth since the summer, a trend that could continue for a while.

Stock markets rose yet again last week, boosted by decent corporate earnings results and optimism over the near-term phase one U.S./China trade deal. The S&P 500 Index climbed 1.2% Energy, technology and industrials led the way, while health care, communications services and REITs lagged. Overall investor sentiment has improved over the last couple of months, but investors remain focused on some key downside risks.

Weekly Top Themes

1. Key equity risks have faded over the past few weeks, but the economic outlook remains uncertain. Economic data has improved since the summer, Brexit shows promise and trade tensions have eased as both the U.S. and China appear eager to negotiate. Contracting global manufacturing and weak global trade levels are key negatives.

2. Manufacturing data shows some positives, but more progress is needed. The U.S. Purchasing Managers’ Index climbed to a surprisingly strong 51.5 in October. This was the second month of expansion and the strongest reading since April.

3. The Fed is likely to cut rates again this week, but we think forward guidance will suggest a higher bar for future cuts.

4. Third quarter earnings results are ahead of expectations. With about half of S&P 500 companies reporting results, earnings are beating expectations by almost 5%, with 73% of companies reporting positive surprises. This remains in line with the average of 5.5% and 71% over the past three years. At this point, earnings per share are on track to come in at around +1% for the quarter.

5. Earnings results are clearly skewing toward domestically focused companies and cyclicals. These areas of the market have been outperforming companies with more international exposure and defensive sectors.

6. Trade uncertainty remains high, but President Trump is pushing hard for some sort of deal. The president appears highly focused on finding a way to both boost economic growth and his approval ratings. A trade deal seems to be a clear path toward accomplishing both.

7. The trend of value stocks outperforming growth could still have legs. Positive economic momentum, central bank easing and the prospects for a trade agreement could benefit value stocks.

What would it take for stocks to break to new ground?

Despite the good news that has pushed stock prices higher since September, equity markets have yet to break out above their July highs. Our sense is that investors remain wary about economic growth and are concerned that corporate earnings expectations remain too high for next year. Economic data has picked up over the last couple of months, but has not notably strengthened. In other words, we’re not seeing as many disappointing numbers but nor are we seeing a rash of positive surprises. Manufacturing remains critical to the outlook, and those numbers still appear troubled. It will take more than a couple of months of decent data before global manufacturing can recover.

Global monetary policy also looks to be a key economic factor. The odds are high that the Fed will cut this week, but we don’t expect a prolonged campaign of interest rate cuts. The good news is that rates are already quite low, so a sustained pause should be enough to keep the expansion on track.

Our outlook for corporate earnings is a bit more troubled. We think earnings will continue to slide and the risk is high for disappointments in 2020. Additional progress on the trade front and/or better news from the manufacturing sector would help improve the corporate earnings outlook, but both of those trends appear elusive at best.

In this environment, we think markets will remain range bound. But if the economy picks up a bit, we think the recent trend of value and cyclical stocks outperforming growth and momentum could continue for a while. We also think some areas of the global stock market (such as emerging markets) could be better positioned than their U.S. counterparts.

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