Global Equity Strategy
August 25, 2015
Sean Lynch CFA®, Co-Head of Global Equity Strategy
Analysis and outlook for the equity market
- This week, the S&P 500 Index entered correction territory for the first time in more than four years.
- All major domestic and international benchmark equity indices have now experienced corrections year to date in 2015.
What it may mean for investors
- This market action gives us concern, but has not changed the fundamentals. We favor capitalizing upon volatility to reposition toward U.S. large-cap and international developed equities.
Four Years and No Longer Counting—An S&P 500 Correction
The S&P 500 Index finally entered correction territory (a 10 percent decline from a prior high) this week. It had been four years (April 2011) since it had suffered a 10-percent correction. The S&P 500 closed at 1893 on August 24—an 11 percent decline from its recent high of 2130 reached on May 21. This large-cap benchmark joins mid-cap, small-cap, emerging-market and international developed equities in registering a decline of 10 percent or more this year. Since 1928, a U.S. equity-market correction has taken place on average every 11 months, so this correction-less market was getting long in the tooth.
Additionally, many global indices are now well off their highs for the year. The primary culprits behind the recent declines are fears that global growth is slowing, China’s economy is becoming more unstable, and commodity prices are weakening.
Our view is that global growth is slowing but not collapsing. China is in a state of transforming its economy, which is going to result in market disruptions and inconsistent data and policy actions. As a result of the volatility in financial markets, on August 24, in a tactical shift, we moved two percent out of high-yield debt and positioned that two percent toward large-cap equities. We continue to be overweight large-cap U.S. stocks and international developed equities. We remain neutral on emerging market, mid-cap, and small-cap equities.
Table 1. Equity-Market Forecasts for 2015
Source: Wells Fargo Investment Institute, Bloomberg, 8/24/15. Forecasts are not guaranteed and may change.
We increase our preference for large-cap stocks
Large-cap domestic stocks currently have strong balance sheets, and earnings should benefit from improving economic conditions in the U.S., Europe, and Japan. We recently lowered our U.S. large-cap earnings forecast, but still believe that large-cap earnings growth in the second half of the year will be higher than in the first half of 2015. Energy has been a drag on earnings to date in 2015, but we believe the lower oil and commodity costs should help to boost margins in many other sectors later this year. The lower energy costs, improved housing market, and steady labor conditions also should result in increased confidence around consumption. We still see strong upside to our year-end, large-cap price target—with the biggest risks being a step back in the earnings outlook or a deterioration in economic fundamentals.
We also continue to be overweight on international developed stocks. These markets also had a rough week as investors worry about the knock-on effects of a slower China. Export-oriented economies like Germany caught the brunt of the decline. The German Dax declined 4.7 percent on Monday and is down 22 percent from the high it reached on April 10 of this year. There have been some concerns that recent weak data readings out of China could place downward pressure on the Eurozone (and broader European) economy, but improving Manufacturing and Services Purchasing Managers’ Index (PMI ) reports, combined with positive export growth from the region to China, continue to reflect expanding economic activity in the Eurozone.
We keep emerging-market stocks neutral and resist the temptation to add
Emerging markets have been the epicenter of the recent decline. In an environment of dollar strength, languishing commodities, and weak equity markets, these headwinds could strengthen or at least remain for a while. Even though a number of emerging markets and currencies are touching multi-year lows, we would resist adding exposure to these markets. The transition of China from a manufacturing economy to one in which services and consumption become the driver was never going to be easy. China’s slowing growth has implications for its trading partners ranging from Southeast Asia to Latin America and Europe. The seemingly uncoordinated actions by the People’s Bank of China (PBoC) and other government bodies has people questioning whether Chinese authorities even have a plan right now to fuel growth. A strong enough policy response from China or other emerging-market economies may help to get the group out of its recent woes. This morning, China cut interest rates and reduced the reserve requirement ratio that banks must set aside, resulting in a strong rally for global equities. However, as we have seen this summer, it is tough—and so far unrewarding—to place hope in the plans of emerging-market central banks and officials.
The recent market action gives us concern, but underlying fundamentals have not changed. Therefore, we would take advantage of the recent weakness and volatility to reposition toward U.S. large-cap and international developed equities.
Weekly Wrap and Look Ahead
All major domestic and international indices were negative for the week and year to date.
|Index||Last week's performance1||2015 YTD performance|
|MSCI Emerging Markets||-5.9%||-13.3%|
1For the week of August 17 – August 21, 2015
Sources: Wells Fargo Investment Institute, Bloomberg, 08/21/15
Seven of 10 S&P 500 sectors outperformed, but all of the sectors lost ground for the week.
|Best Performing Sectors||Last week's performance2||Worst Performing Sectors||Last week's performance2|
|Telecom Services||-2.6%||Information Technology||-7.4%|
2For the week of August 17 – August 21, 2015.
Sources: Wells Fargo Investment Institute, Bloomberg, 08/21/15
This week, the stock market will be trying to find its footing in the wake of last week’s major selloff. The spark that set off the market’s reaction was China’s PMI survey that is a gauge of manufacturing activity. Investors expected a weak number, but the actual result was slightly below expectations.
The fear over the magnitude of any potential global slowdown in economic growth is driving financial markets right now in this traditionally low-volume period (the month of August). In our opinion, China’s economy is stabilizing at a lower growth rate in response to the government’s efforts to shift that country’s economy from one reliant upon exports to one that is more dependent on domestic consumption. We are looking for economic growth of 6.8 percent in China this year versus the government’s target of seven percent.
This week, we expect the stock market to be volatile. Economic reports of interest include the Case/Shiller Home Price Index, new home sales, consumer confidence and the first revision to second-quarter gross domestic product (GDP) (initially reported as 2.3 percent). Investors will be looking at each of these reports and determining how the results will affect the Federal Reserve’s (Fed) decision to alter monetary policy at the September (16/17) Federal Open Market Committee (FOMC) meeting. Given the selloff in global stock markets and turmoil in emerging and commodity markets, we suspect that the probability of a rate move next month has diminished to some extent.
|Sector||S&P Weighting*||Wells Fargo Investment Institute Guidance|
|S&P 500 earnings estimate for 2015||$122.00|
|S&P 500 year-end 2015 target range||2,150-2,250|
*Sector weightings may not add to 100% due to rounding. Weightings as of 08/24/15 close.
Sources: Wells Fargo Investment Institute, Bloomberg 2015.
Sean Lynch 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 current role, Mr. Lynch is responsible for developing global equity strategy and oversees proprietary equity strategies as well as the equity trading desk. He has represented Wells Fargo to the media on numerous occasions, providing insights and perspectives on the global markets. He has also written extensively about global issues and the implications on client portfolios, appearing in Bloomberg, The Wall Street Journal, USA Today, Money, and on CNBC.
Mr. Lynch has been with Wells Fargo for 17 years. Prior to his current role, he served as a global investment strategist for Wells Fargo Private Bank. He has traveled extensively internationally—from Asia to South America to Europe—to gather firsthand knowledge and information, and has shared his observations and perspectives with clients and team members. He has been in the investment management and trust industry for 24 years.
Mr. Lynch earned a Bachelor of Science in Business Administration, specializing in Accounting and Finance, from the University of Nebraska-Omaha. He is a CFA® charterholder and a former president of the Omaha-Lincoln Society of Financial Analysts. Mr. Lynch is located in Omaha, Nebraska.
*As of Sept. 30, 2014
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DJIA is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.
German Dax is a stock index that represents 30 of the largest and most liquid German companies that trade on the Frankfurt Exchange.
Manufacturing and Services Purchasing Managers’ Index (PMI) - Purchasing Managers' Indices (PMI) are economic indicators derived from monthly surveys of private sector companies. Markit Group and the Institute for Supply Management separately compile The Purchasing Managers' Index (PMI) surveys on a monthly basis by polling businesses that represent the makeup of the respective sector. The surveys cover private sector companies, but not the public sector.
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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.
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The Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000 Index, which represent approximately 25% of the total market capitalization of the Russell 1000® Index.
The Russell 1000® Index measures the performance of the 1,000 largest companies in the Russell 3000 Index, which represents approximately 92% of the total market capitalization of the Russell 3000 Index.
The Russell 3000® Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market.
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.
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