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Global Equity Strategy

February 3, 2016

Stuart Freeman, CFA®, Co-Head of Global Equity Strategy
Scott Wren Senior Global Equity Strategist

Analysis and outlook for the equity market

  • With 43 percent of S&P 500 Index companies having reported earnings, market-capitalization-weighted fourth-quarter earnings have risen by 6.8 percent to date.
  • Energy-sector earnings and the U.S. dollar remain headwinds for large-cap earnings in 2016.

What it may mean for investors

  • Although the New Year opened with a correction and a defensive market personality, we believe the cyclical bull market remains in place.

Fourth-Quarter Earnings Creep Higher

With 43 percent of S&P 500 Index companies having reported to date, fourth quarter market-capitalization-weighted earnings have risen by 6.8 percent on a roughly 4.8 percent decrease in revenues. Once again, declining energy-sector earnings are dominating the fourth-quarter earnings story as West Texas Intermediate (WTI) crude-oil prices dropped roughly 17.8 percent during the quarter and 10.8 percent in December alone. Thus far, a healthy 76.2 percent of reporting companies have registered earnings that were ahead of consensus expectations. We have plotted the history of the percentage of outperforming earnings (positive surprises) results and underperforming (negative surprises) results in Chart 1.

Chart 1. Positive and Negative Earnings Surprises: Companies in S&P 500 IndexChart 1. Positive and Negative Earnings Surprises: Companies in S&P 500 Index
Sources: Bloomberg, Wells Fargo Investment Institute, 2/1/16. Past performance is not a guarantee of future results.

On the other hand, the overall breadth of fourth-quarter earnings, thus far, has been relatively soft. For every company that has reported lower earnings, only 1.2 companies have reported higher earnings (a 1.2:1 ratio). Over the prior four quarters, that breadth ratio was much stronger (2.7:1, 1.9:1, 1.7:1, and 1.7:1 for the fourth quarter of 2014 through the third quarter of 2015, respectively). This represents the softest earnings breadth since the third quarter of 2009, which was very early in this economic cycle. In 2014, this ratio was a strong 3.6:1. Yet, investors should remain mindful that 57 percent of earnings reports are not yet in, and that the energy sector and the materials sector are likely to register overall earnings downticks for the fourth quarter.

Excluding the energy sector, market-capitalization-weighted, fourth-quarter earnings have risen by 10.0 percent thus far. Ex-energy, revenues also are modestly higher. Earnings results were reported as follows during the first three quarters of 2015:

  • First quarter 2015: Earnings-per-share +5.8 percent, +11.7 percent ex-energy
  • Second quarter 2015: Earnings-per-share +2.7 percent, +8.4 percent ex-energy
  • Third quarter 2015: Earnings-per-share +5.0 percent, +9.9 percent ex-energy

Overall, with 43 percent of companies having reported, fourth-quarter market-capitalization-weighted earnings, by sector, are as follows:

2015 Fourth-Quarter Sector Performance: S&P 500 Index2015 Fourth-Quarter Sector Performance: S&P 500 Index
Sources: Bloomberg, 12/31/15. Telecom Services data represents two of five names reporting. Utilities data represents four of 29 companies reporting.

In 2015, the year-to-year WTI crude oil price comparisons were +51.9 percent, -41.7 percent, -50.4 percent, and -36.5 percent for the first through fourth quarters, respectively. If crude-oil prices remain at the current level for the first quarter of 2016, the year-to-year price comparison would be roughly -35 percent, which should correlate closely with the first-quarter energy revenue trend.

For 2015, the first- and second-quarter revenue and earnings results were also challenged by year-to-year increases in the U.S. dollar vs. other currencies (up roughly 20 percent), followed by a 15.8 percent rise in the dollar during the third quarter and an 11.5 percent increase in the fourth quarter. Throughout the year, the strong dollar made it somewhat more difficult for domestic companies to be price-competitive in some international industries. A strong dollar also often negatively impacts earnings results as companies translate international revenues and profits into dollars. Currently, the dollar is only roughly 4.7 percent higher than one year ago. We believe that dollar comparisons are likely to be more favorable for earnings as 2016 progresses.

We continue to expect that low energy prices, low inflation and low interest rates should benefit consumer behavior and overall non-energy earnings in 2016, even though energy-sector earnings appear likely to be a drag on overall S&P 500 earnings. We continue to expect a market return from the energy sector in the coming months. This is particularly likely given the continued softness of crude-oil prices through the fourth quarter and into 2016. In order to keep portfolios aligned with our suggested sector advice, we continue to recommend that investors carry an evenweight (or neutral) position in the energy sector. Therefore, and in keeping with our outlook, we are modestly rebalancing our energy-sector weighting recommendation to 6.5 percent. We recommend that investors move those incremental funds to the already-overweighted Consumer Discretionary sector.

Weekly Wrap and Look Ahead

All major domestic and international indices were positive for the week and negative year to date.

Index Last Week’s Performance1 2015 YTD Performance
S&P 500 +1.7% -5.1%
DJIA +2.3% -5.5%
NASDAQ +0.5% -7.9%
Russell 2000 +1.4% -8.8%
MSCI EAFE +1.5% -7.2%
MSCI Emerging Markets +4.5% -6.5%

1. For the week of January 25 – January 29, 2016
Sources: Wells Fargo Investment Institute, Bloomberg, 01/29/16

Seven of 10 S&P 500 Index sectors outperformed the index and nine of 10 gained ground for the week.

Best-Performing Sectors Last Week’s Performance2 Worst-Performing Sectors Last Week’s Performance2
Telecom Services +4.3% Health Care -1.9%
Energy +4.2% Materials +0.7%
Utilities +3.7% Consumer Discretionary +1.2%

2. For the week of January 25 – January 29, 2016
Sources: Wells Fargo Investment Institute, Bloomberg, 01/29/16
Past performance is no guarantee of future results.

Will the stock market’s day-to-day fluctuations continue to follow the price of crude oil? That is one question we might get some clarity on if trading action over the past couple of days is any indication. We have suggested that, at some point, the two would decouple. Yet, trying to determine the timing has been difficult. We will be closely watching the two markets as we continue to believe lower energy prices will have a beneficial effect on other segments of the economy and on consumer spending.

This week, investors will also hear more fourth-quarter earnings results from a number of S&P 500 companies. We are in the busiest part of the earnings-reporting season. Earnings are on track to be flat to slightly positive, but the probability of a big overall beat or miss is small given the modest-growth nature of the domestic economy. As we remind our readers virtually every earnings reporting season, it is important to remember that fourth-quarter earnings are what happened in the past. They do not tell us what will happen in the future, and we are focused on the future in the Wells Fargo Investment Institute Equity Strategy group. The bottom line is that earnings are a lagging, not a leading, indicator. We believe that earnings growth in 2016 will show meaningful improvement compared to last year.

The most important economic report of this week, in our opinion, will be Friday’s employment report covering January. We expect approximately 190,000 new non-farm payroll jobs to have been added last month. Perhaps the most important segment of this report will be the average hourly earnings growth rate over the past 12 months. We look for something less than a 2.5 percent increase, which, in turn, is well below the level that the Federal Reserve would like to see (3 percent to 4 percent based on Chairwoman Janet Yellen’s past comments).

Sector S&P Weighting* Wells Fargo Investment Institute Guidance
Consumer Discretionary 12.9% Overweight 14.9%
Consumer Staples 10.7% Underweight 8.5%
Energy 6.5% Neutral 6.5%
Financials 15.9 Neutral 16.5%
Health Care 14.8% Neutral 14.8%
Industrials 9.8% Overweight 11.6%
Information Technology 20.7% Overweight 21.8%
Materials 2.6% Neutral 3.0%
Telecom Services 2.7% Neutral 2.4%
Utilities 3.3% Underweight 0.0%
S&P 500 Earnings Estimate for 2016 $130.00
S&P 500 Year-end 2016 Target Range 2,230-2,330

*Sector weightings may not add to 100% due to rounding. Weightings as of 2/01/16 close. Targets are not guaranteed and may change.
Sources: Wells Fargo Investment Institute, Bloomberg, 2/01/16.

Scott WrenAbout Scott Wren

Scott Wren is a senior global equity strategist for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.

Mr. Wren produces strategy and guidance recommendations for global equities. With his knowledge of the financial markets, he is often quoted in national media outlets including Reuters, The Chicago Tribune, The Los Angeles Times, The Washington Post, The Associated Press, and The Wall Street Journal. He has appeared in interviews on CNBC, Bloomberg TV, Fox Business News, and Nightly Business Report. Prior to joining Wells Fargo Advisors predecessor A.G. Edwards in 1998, Mr. Wren worked as a senior foreign exchange dealer for The Boatmen’s National Bank of St. Louis. He began his career on the trading floor of the Chicago Mercantile Exchange and has more than 25 years of experience in financial services.

He received a Bachelor of Science in Business Administration from the University of Kansas and a Master of Finance from Saint Louis University. He is located in St. Louis, Missouri.

Stuart FreemanAbout Stuart Freeman

Stuart Freeman is the co-head of global equity strategy for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.

In his role, Mr. Freeman identifies potential long-term buying opportunities within the equity markets by analyzing sub-industries and broader market sectors. He also produces cross-analyses of recent versus historical economic landscapes, and develops equity market earnings projections and price target ranges. Mr. Freeman is frequently quoted in the national media, including The Wall Street Journal, USA Today, Forbes, Money, Bloomberg News, CNBC, Fox Business, and MarketWatch. Mr. Freeman began his career at Wells Fargo predecessor firm A.G. Edwards in 1982 as a securities research analyst following the healthcare industry. He has extensive experience communicating his investment views to various audiences through written publications, presentations, and media appearances.

Mr. Freeman earned a joint Bachelor of Science in Business Administration/Master of Business Administration with a concentration in Finance from Washington University in St. Louis. He is a CFA® charterholder and member of the St. Louis Society of Financial Analysts. Mr. Freeman is based in St. Louis, Missouri.

Risk Factors

All investing involves some degree of risk, whether it is associated with market volatility, purchasing power or a specific security.

Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments.

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

Technology and Internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market.

There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained.


An index is unmanaged and not available for direct investment

DJIA is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.

MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

NASDAQ is an unmanaged group of the 100 biggest companies listed on the NASDAQ Composite Index. The list is updated quarterly and companies on this Index are typically representative of technology-related industries, such as computer hardware and software products, telecommunications, biotechnology and retail/wholesale trade.

Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.

Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000 Index, which represent approximately 25 percent of the total market capitalization of the Russell 1000® Index.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market. The Index is unmanaged and not available for direct investment.


Global Investment Strategy (“GIS”) is a division of Wells Fargo Investment Institute, Inc. (“WFII”). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by the GIS division of WFII. Opinions represent GIS’ opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

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