Global financial markets still have room to run this year, even as the prospect of a global economic slowdown nears, according to 2018 midyear outlook reports from Wells Fargo.
U.S. equities, boosted by recent tax reforms, remain attractive, Wells Fargo analysts say, and global growth will likely continue. The outlooks call for an S&P 500 range of 2,800-2,900 by year-end, up slightly from the current levels, though the teams expect continued bouts of volatility.
The reports — Wells Fargo Investment Institute’s 2018 Midyear Outlook, Late Cycle Doesn’t Mean End of Cycle, and Wells Fargo Asset Management’s 2018 Midyear Investment Insights (PDF)— reflect the insights and perspectives of market strategists and portfolio managers to help investors consider investing decisions and implications for their portfolios. The midyear reports are consistent with the groups’ 2018 investment outlooks, whose authors foresaw another year of growth and a further maturing of a U.S. bull market that they believe still has room to run.
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Although Wells Fargo isn’t expecting a U.S. recession in the next 12 months, “historical data indicates that equities may likely remain attractive as we continue to move through this later stage in the economic cycle,” said Sameer Samana, global equity and technical strategist for Wells Fargo Investment Institute.
He noted that large-cap equities — companies with a market capitalization of at least $10 billion — have posted returns averaging 24.2 percent in the 12 months before a recession, according to Wells Fargo Investment Institute’s analysis of data going back to 1926.
“Our highest conviction call is a preference for U.S. equities over developed and emerging markets, in large part because of benefits from tax reform,” Samana said. “U.S. tax cuts seem to be giving U.S. investors more reason to invest at home.”
That includes Wells Fargo Investment Institute’s expectation that profits for large-cap equities, as a percentage of sales, will reach 11.9 percent in 2018, compared with 10.8 percent in 2017. The midyear 2018 outlook also credits broadening economic growth from 2009 — backed by strong household and business spending — for driving the preference for U.S. equities.
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Meanwhile, the key theme of Wells Fargo Asset Management’s midyear outlook is “good old-fashioned security selection” — identifying companies with a high potential for strong earnings growth, supported by management teams focused on generating growth, said Brian Jacobsen, the group’s multi-asset strategist.
“Some parts of the global market appear fairly valued or overvalued and others appear undervalued — making it tricky for investors to navigate this landscape of differing valuations without selectivity in their portfolios.”
Surprises in oil and energy
Both Jacobsen and Samana said market surprises in oil and energy in the first half of the year shaped their outlooks for the rest of 2018.
“Oil prices went up rapidly and have hovered there for a while,” Jacobsen said. “Some of our portfolio managers favored energy companies when the price of oil was below $50 per barrel and have enjoyed the ride up as oil hit $70 per barrel.
Added Samana, “The rally in crude oil and energy stocks has gone further than we expected, and this may be a good time to pare back investment exposure, as we foresee declines to hit the $50 to $60 range by the end of the year.”
Monetary policy impact
Global growth began to synchronize in late 2016, but with each country at distinctly different phases of their economic cycles, the Wells Fargo Asset Management outlook noted. This is why less accommodative global monetary policy could add more volatility to global financial markets, Jacobsen said.
However, the different growth rates also mean that, “when the U.S. looks to be getting winded, other countries may be able to do some of the heavy lifting,” he added.
“In a globally interconnected world, the Federal Reserve can calibrate its policies for the U.S. — with an attempt to avoid negative spillovers for other countries — while the Bank of Japan and European Central Bank can calibrate their policies for their economies,” Jacobsen said.
In the U.S., Wells Fargo Investment Institute analysts anticipate additional interest rate hikes, which may lead to a Federal funds target rate range of 2.00-2.25 percent by year’s end.
But Jacobsen and Samana said the Fed must tread carefully.
“If the Fed increases its pace of hikes, the risks of a policy mistake increase,” Samana said. And with that, he said, comes the potential that the yield curve could invert — when the yield on 10-year Treasury notes falls below that of two-year Treasury notes.
“Historically,” Samana said, this is “a sign that recession may be on the horizon.”
Caution: heightened volatility ahead
The reports expect heightened volatility in the markets — due in part to trade-war worries — to remain a concern for investors.
Jacobsen cautions investors against the temptation of trying to time the market on these worries — making buy or sell decisions by attempting to predict future market price movements — and instead favors a “be watchful and wait” approach.
“Think about prices and value,” he said. “When prices get too divorced from value, or when the fundamental economic backdrop changes, you tend to get equity that moves lower,” he said.
Wells Fargo Investment Institute anticipates solid earnings growth through 2019, benign inflation, and interest rates that will slowly move higher.
Coupled together, those factors may “set the stage for at least a few more years of solid equity returns,” concluded Samana.
The views expressed and any forward-looking statements are as of June 18, 2018, and are those of Wells Fargo Investment Institute and Wells Fargo Asset Management. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the authors and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. Wells Fargo Investment Institute and Wells Fargo Asset Management disclaim any obligation to publicly update or revise any views expressed or forward-looking statements.
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