Nuveen: Despite A Slight Pullback In Stocks, We Remain Optimistic

Weekly top themes

1. The Federal Reserve delivered a mixed bag. As expected, the Federal Reserve raised rates 0.25% to a target range of 2.00% to 2.25%. However, the Fed’s removal of the word “accommodative” from its statement drew greater attention from investors, causing some to speculate that the Fed is nearing its neutral rate. However, Chairman Powell noted the change in language doesn’t impact the likely path of policy.

2. Stock markets fell in the U.S. and Europe, but Asia was a bright spot. The Italian government’s 2.4% deficit projection for fiscal 2019 was higher than expected, causing some price weakness in European markets. Asian shares fared better than the U.S. and Europe, with Japan out in front.

3. U.S. trade negotiations continue to be in the spotlight. Following a prospective deal with Canada, trade issues between the U.S. and most of the world appear generally positive. But the U.S./China relationship is certainly deteriorating.

4. Inflation appears well contained, but that won’t last forever. Business owners are likely to raise prices to compensate for wage hikes and higher prices as a result of the developing tariff war. Inflation is well contained, but creeping higher. If inflation continues to rise in 2019, the Fed may be forced to take action. Relatedly, the Fed recently raised its GDP growth prospects for 2018 to 3.1%.²

5. Interest rates must be noticeably higher to slow the pace of equities. We don’t think the stock market will slow until rates are high enough to slow the overall economy. A 10-year Treasury yield in a range of 3.75% to 4.25% would be cause for concern.

Reasons for optimism and caution

Currently, we offer reasons to be both optimistic and cautions, as adapted from J.P. Morgan Research.³

REASONS FOR OPTIMISM
1) U.S. economic growth remains solid despite trade headwinds and higher rates.
2) Corporate fundamentals are still very healthy.
3) Valuations aren’t too high.
4) Trade tensions haven’t detracted from economic growth.
5) The net supply for stocks continues to shrink, creating a favorable tailwind for prices.
6) Lowered tax rates should insulate the market from potential fallout from November elections.
7) Dramatic political changes may not occur in November’s U.S. election.

REASONS FOR CAUTION
1) Growth outside the U.S. is mixed.
2) The U.S.-China relationship is getting worse.
3) Companies are increasingly concerned about the effects of the trade tariffs.
4) Business leaders continue to face cost pressures.
5) Modest rises in interest rates and inflation could continue to weigh on valuations.
6) Central banks are beginning to tighten interest rates.
7) Global political issues continue to exist, particularly regarding Italy, Germany, Brexit and U.S. midterm elections.

The equities backdrop remains positive

Corporate fundamentals remain strong, but the upcoming third quarter earnings season may reveal future problems. Bullish investors are targeting earnings of around $178 per share with a price-earnings ratio (P/E) of 17 in 2019.¹ These earnings and P/E assumptions leave little room for error.

Overall, equities do not face enormous downside potential, and we think a focus on cyclicals and emerging markets may offer better risk-return potential.

Source: https://www.nuveen.com/bob-doll-weekly-commentary