U.S. stocks experienced their third straight week of gains, with the S&P 500 Index rising 2.6% and gaining more than 10% since Christmas Day.1 Investors were encouraged by comments from the Federal Reserve indicating a less aggressive policy stance and a sense that trade issues may be improving. Strong outflows from stock funds have also been an important contrarian indicator that investor capitulation had reached a limit. Several market areas were standout performers last week, including industrials, retail sectors, technology and energy, which was helped by a 7.5% climb in oil prices.1 A near -term consolidation is possible, given the strong climb over the last few weeks, but a return to December’s lows seems unlikely.


1. The Fed should remain data dependent, which should be good for stocks. Fed comments in October seemed to indicate it would continue to raise rates and sell off its balance sheet for the foreseeable future. But Fed Chair Jerome Powell walked back those comments in early January, causing investors to breathe a sigh of relief. If concerns about the global economy ease, we could see a couple of additional rate hikes this year. Conversely, weakening economic sentiment could cause the Fed to stand pat. In any case, the central bank appears focused on continuing to promote economic growth.

2. Trade concerns have eased a bit, at least for now. At the minimum, the United States and China appear committed to additional trade negotiations. Given that both President Trump and President Xi are eager for a political win makes it likely that some sort of deal could be reached.

3. The jobs market remains an important source of economic strength. December’s employment report was, in a word, stellar. We are keeping a close watch on wages, which have been accelerating in recent months as the jobs market tightens. This increase could represent an eventual source of inflation.

4. Manufacturing is slowing, but remains healthy. January’s ISM manufacturing data dropped sharply, but remained in expansion territory.2

5. The ongoing government shutdown could become a negative for economic growth. The current shutdown now has the dubious distinction of being the longest in history. Last week, JP Morgan lowered its forecast of first quarter GDP growth from 2.25% to 2%.3 The longer this shutdown continues, the more economic damage it is likely to cause.


Despite the late-2018 correction, fundamentals remain solid

Stocks have rebounded strongly over the last three weeks, regaining almost half of what they lost in the sharp meltdown in the fourth quarter of 2018. Greater stability in bond yields has certainly helped equity market sentiment. We think bond markets will likely remain relatively stable given that the Fed looks to be backing off from its rate-tightening campaign and a spike in economic activity seems unlikely. At the same time, news on the trade front appears to be improving, even if specifics about a deal remain scarce. Other geopolitical risks could persist, but outside of trade we doubt any of them will significantly affect global economic growth. A combination of greater bond market stability, a pause in the Fed’s rate hiking and some improvement around economic sentiment may help equity markets continue to recover.

Although the financial headlines have been pessimistic since October, overall economic and market fundamentals remain solid. Monetary and fiscal policy remain equity-friendly, the economy is still growing, companies are enjoying solid profit margins and corporate earnings are expanding. In other words, we see no real signs of a recession on the horizon.

That said, though, we think the highs for the current bull market may have already been realized last year. We believe volatility is likely to remain relatively elevated, which means we could see another near-term selloff at any point. Overall, we think equity markets are topping out, but that process can take quite a while and there is still room for upside. To us, this suggests that 2019 will be a year where investment selectivity is critical. In particular, we suggest focusing on companies with higher earnings quality and lower leverage.

Courtsy of Bob Doll @ Nuveen

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