Global Equity Strategy
November 24, 2015
Stuart Freeman CFA®, Co-Head of Global Equity Strategy
Sean Lynch CFA®, Co-Head of Global Equity Strategy
Scott Wren Senior Global Equity Strategist
Analysis and outlook for the equity market
- We recently increased our year-end 2016 domestic equity price targets.
- These adjustments reflect increased confidence in the near- and intermediate-term potential for the U.S. economy. Initial jobless claims (forward-looking) have been persistently pointing toward continuing modest job growth, and the Conference Board’s Leading Economic Index (LEI) ticked upward again in October.
What it may mean for investors
- We continue to recommend that investors look to 2016 as a year in which we expect higher earnings and attractive equity returns from current levels.
A Deeper Dive into Our Domestic Equity View
We raised our year-end 2016 domestic equity targets this week and wanted to offer additional insight into what has changed over the past couple of months to warrant the adjustment.1 These changes include further strengthening of the U.S. economy, the improvement in labor market conditions and inflationary pressures as reflected in the “misery index” (sum of inflation and unemployment), and lessening of investor concern about Federal Reserve (Fed) rate increases.
First, following the August correction, we expected that economic data would improve only slowly. But the U.S. data have improved faster and more impressively than we had expected, returning confidence in the economy to a stronger trajectory. In particular:
- Leading economic indicators (as measured by the Conference Board’s LEI) have risen at a 3.1 percent annualized pace over the past six months. The downtick in August and September proved to be temporary, and October’s number returned the index to its positive trend. Further, the breadth across the components last month was the best since April 2015.
- U.S. manufacturing has resisted the global slowdown since mid-year and is doing so despite a surge in the dollar since the end of September. The October manufacturing output gain wiped out August and September losses, even as mining and utilities continue to struggle with global commodity oversupply and the emerging-market slowdown.
- Initial unemployment claims, a leading indicator for the labor market, have come in even lower than our model has expected and support higher valuations than in our initial target, as shown in chart 1.
Our second reason for the change also reflects an improving economy and focuses on two key components, an improving labor market and the lack of inflation. These two factors, along with housing and asset values, are the main drivers of consumer confidence.
Chart 1. Average U.S. Weekly Unemployment Claims: Actual vs. WFII Trend Analysis Forecast
Source: FactSet and Wells Fargo Investment Institute (WFII), 11/23/15. Monthly averages of weekly data: January 2015 - October 2015; Forecasts through April 2016.
Chart 2 indicates how this economic environment differs from the past few. The misery index has fallen to levels not seen since the mid-1950s. Consumers should feel better about their job prospects, home and asset values, and, importantly, the dramatic fall in energy prices (one of their largest consumables). All of this bodes well for an economy that is driven by consumption.
Chart 2. Misery Index: U.S. Unemployment Plus Consumer Price Inflation (CPI) — 1948 to 2015
Source: Bloomberg and Wells Fargo Investment Institute,11/23/15. Monthly data, January 1948 - October 2015
Lastly, we believe the Fed’s expected path of rate increases will be more benign than in previous cycles. We are expecting higher interest rates and inflation next year—as reflected in our year-end 2016 target range of 0.75-1.00 percent for the fed funds rate and our 2.0 percent forecast for consumer price inflation next year. Chart 3 contrasts consumer price inflation with the price-earnings (P/E) ratio, while Chart 4 compares the P/E ratio and the six-month U.S. Treasury Bill yield. In the past, rising inflation and interest rates have coincided with lower valuations (i.e., lower P/E ratios). These charts show that, even with the forecast changes, the levels of inflation and interest rates are below the levels where valuations were vulnerable in the past. Our quantitative research suggests that year-end 2016 valuations could be somewhat higher than current trailing 12-month valuations.
Chart 3. S&P 500 Index Price-Earnings Ratio vs. U.S. Consumer Price Inflation
Source: Bloomberg and Wells Fargo Investment Institute, 11/23/15. Data are quarterly, 9/30/1985 - 9/30/2015
Chart 4. S&P 500 Index Price-Earnings Ratio vs. Six-Month U.S. Treasury-Bill Yield: 1985-2015
Source: Bloomberg and Wells Fargo Investment Institute, 11/23/15. Data are quarterly, 9/30/1985 - 9/30/2015
Our target changes come relatively quickly after our initial 2016 targets were set, but they also reinforce our long-standing and constructive view on U.S. equities. We continue to see U.S. equities as attractively valued. Despite improving consumer confidence, market sentiment is not extreme. After adjusting for low interest rates, the forward-looking S&P 500 Index P/E valuation suggests that the market has been less expensive only about 24 percent of the time over the past 20 years. We have maintained a tactical overweight since June 2014 and were one of the few groups to increase our overweight to U.S. equities on August 24, 2015, at the peak of global uncertainty. We now see the economic data as indicating a faster rebound than we had expected, and the revised target prices reflect our improved confidence with this asset group.
We made no adjustments to our international developed or emerging-market equity targets. We continue to believe that the central banks in the developed world (the European Central Bank and Bank of Japan) will provide additional stimulus as needed to support the developed markets. Our belief is that earnings will drive the markets next year rather than valuation improvements. With respect to emerging markets, the recent underweight reflects our concern over how this group will deal with pressure on commodities and their currencies. Emerging-market earnings remain well below their highs of 2011, and it will take some time to get back to those levels.
We continue to believe that investors should remain overweight large-cap U.S. and international developed equities, neutral on U.S. mid- and small-cap stocks and underweight on emerging-market equities. Within U.S. equity markets, our preference for large-cap equities over mid- and small-cap stocks is based on relative earnings-growth potential, valuations and the stage of this economic cycle. While we expect mid- and small-cap equities to move higher, we also believe their performance will lag that of the large-cap S&P 500 Index.
Target Increases for Large Cap, Mid Cap and Small Cap U.S. Equities
Source: Wells Fargo Investment Institute, 11/23/15.
Weekly Wrap and Look Ahead
All major domestic and international indices were positive for the week, but results were mixed year to date.
|Index||Last Week’s Performance1||2015 YTD Performance|
|MSCI Emerging Markets||+2.7%||-9.6%|
1. For the week of November 16 – November 20, 2015.
Sources: Wells Fargo Investment Institute, Bloomberg, 11/23/15
Two of 10 S&P 500 Index sectors outperformed the Index and all 10 gained ground for the week.
|Best-Performing Sectors||Last Week’s Performance2||Worst-Performing Sectors||Last Week’s Performance2|
2. For the week of November 16 – November 20, 2015.
Sources: Wells Fargo Investment Institute, Bloomberg, 11/23/15
Past performance is no guarantee of future results.
This week’s economic report calendar is full, but there will be four pieces of information that will garner most of our attention.
Rising consumer confidence has been one of the keys to our positive outlook for the stock market over the past five years. Consumers are feeling much better now than in the depths of the financial crisis, and we continue to believe that confidence will increase further over the next 12 months. The Conference Board released its latest reading on consumer confidence this week. We believe that the reading of 90 keeps this gauge on its positive uptrend. In addition, the University of Michigan preliminary November consumer confidence number is at a four-month high and near the cycle high. Of course, it is important to remember that these confidence gauges do not move in a straight line. Not every reading has been higher than the previous month. The trend is what is important, and we believe that the trend will continue to be up.
|Sector||S&P Weighting*||Wells Fargo Investment Institute Guidance|
|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 11/23/15 close. Targets are not guaranteed and may change.
Sources: Wells Fargo Investment Institute, Bloomberg, 11/23/15.
1 Tactical Strategy Update: Increasing Our Year-End 2016 Domestic Equity Target Ranges, Wells Fargo Investment Institute, 11/24/15.
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.
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.
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.
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Stocks are subject to market risk which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors.
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