Key Points
• Equities endured a second week of negative returns for the first time since January.
• The Trump administration has proved to be unpredictable in matters of geopolitical and economic policies, which causes more uncertainty for markets.
• We think volatility will rise from here, but staying with a pro-growth investment stance makes sense.
The broad move away from equities continued for a second week as investors focused on escalating risks in Syria, Afghanistan and North Korea. The S&P 500 Index fell 1.2%, marking the first back-to-back weekly declines since January.1 Treasury yields also fell, the dollar was down and oil and gold prices rose.1
Weekly Top Themes
1. Investors have so far reacted only modestly to recent U.S. military action, but it does present possible financial and market risks. In particular, recent actions highlight the unpredictability of President Trump’s geopolitical views since he was adamantly against previous missile strikes in Syria. Unpredictability isn’t necessarily a bad trait for a politician, but it does increase the degree of unknowns for financial markets.
2. Likewise, the Trump administration’s economic views do not match those of the campaign. As President, Trump has so far softened his position on trade deals and has put little focus on possible infrastructure spending increases. Perhaps most surprisingly, Trump recently indicated he may re-nominate Janet Yellen as Fed Chair despite previous harsh criticism of her tenure.
3. We do not believe the rally in Treasuries is a signal of weaker economic growth. There may be more negative economic surprises from here, but those would come after a nearly uninterrupted string of positive ones.
4. Corporate profit margins may come under pressure, which would act as a headwind for earnings. With wage levels on the rise, companies may have a hard time passing along higher costs to consumers. This could be particularly difficult for many U.S. corporations since compensation costs represent two-thirds of total U.S. business costs.2
We believe non-U.S. equities are on the verge of an outperformance trend. We still expect U.S. stocks to produce positive returns over the coming year, but 5. U.S. equities are likely to lag their international counterparts.
Despite Growing Risks, Equities Should Outperform Bonds
U.S. equities have essentially treaded water over the last two months following a strong post-election rally. At the same time, bond yields have retreated, commodity prices flat-lined and inflation expectations have come down. While some of these moves represent a consolidation from overbought equity conditions, we also think they reflect rising investor concerns over a number of risks.
Chief among the risks may be a growing recognition that political optimism was too high. The failure of the Republicans to “repeal and replace Obamacare” calls into question the future for tax reform and other big-ticket economic items. At a minimum, investors are ratcheting back expectations for how effective pro-growth policies could be over the next 6 to 12 months.
At the same time, expectations for economic growth have declined somewhat. We don’t think we will see a slowdown, but the near non-stop pace of positive economic surprises that have been in place since October may be coming to an end, marked most recently by a disappointing March jobs report. Related to this slight shift in economic conditions, the Federal Reserve is no longer as accommodative as it once was. A moderation in growth data or a more aggressive Fed could prompt some investors to adopt a more cautious approach.
Despite these near-term risks, however, we believe the long-term outlook for equities remains constructive. Leading economic indicators in the United States are positive. And around the world, growth appears to be solidifying, with manufacturing activity improving, global trade levels rising and deflationary risks diminishing. And while political risks are growing both in the U.S. and around the world, we still think President Trump will be able to deliver on at least some of his pro-growth promises.
U.S. equities are not inexpensive by historical terms, but we still think equities look more attractive to bonds, which appear expensive. Over the next 6 to 12 months, we think bond yields will rise and global equity prices will appreciate. This outlook suggests a pro-growth investment stance continues to make sense. Volatility is also likely to rise, but we encourage investors to ride out near-term market disruptions and focus on long-term goals.