Market Commentary

• We expect lending institutions both small and large will likely further tighten loan standards, which may negatively impact smaller companies seeking operating or equipment loans.
• We have concerns and believe equity markets may likely see downside volatility in coming months as the economy stumbles and earnings prospects deteriorate.

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Clearly, over the last 2½ weeks, the financial markets have experienced a jump in volatility as concerns over the safety and strength of the banking system have gripped investors both here and abroad. Government officials in the U.S. and Europe took quick action to address concerns. Markets have been calmed to some extent as a result, but many investors are waiting for “the next shoe to drop.”

But after all the recent volatility and fears, many investors might be surprised when they realize that, despite the uncertainty, the S&P 500 Index has rallied to finish with a gain of 1.4% in both of the last two weeks. The stock market has indeed held in better than expected. But we believe the market action of the last 10 or 12 trading days should hardly be taken as a signal that all is clear and brighter skies are in the immediate future.

Our analysis continues to suggest an economic slowdown is underway, inflation is still too high for the Federal Reserve (Fed), and investors broadly have not reconciled themselves to these two eventualities. And we believe the recent banking turmoil’s likely effect on credit standards and credit availability will further slow the economy without deterring the Fed’s path to higher interest rates.

To be more specific, we expect lending institutions both small and large may further tighten loan standards, which may negatively impact smaller companies seeking operating or equipment loans. Fed Chair Jay Powell last week stated that “tighter credit conditions can be thought of as a substitute for rate hikes.” Per the Fed chair, this likely reduction in credit availability in the U.S. economy will be part of the monetary policy decision-making process in the months to come. Less credit availability is an additional headwind for the economy. The equity market took this as a sign our central bankers are unlikely to hike the fed funds target rate much further, if at all, from the current 4.75% to 5% range.

Still, the issue of rates and what the Fed is going to do is likely to keep markets guessing over the course of the next couple of Fed meetings (May and June) if not longer as inflation remains far above the Fed’s stated long-term average target level of 2%. The services segment of the economy has continued to do well and is a source of elevated inflation while most gauges of manufacturing segment activity reflect a still slow or modest contraction.

Tentative markets have taken a so-far, so-good approach. Treasury yields are down, and stocks are up relative to levels seen during the initial response to the banking-induced selloff a couple of weeks ago. But we still have concerns and believe equity markets may likely see downside volatility in coming months as the economy stumbles and earnings prospects deteriorate. While we seek to take advantage of any meaningful pullback in the stock market from current levels, we believe now is not the time to broadly buy equities and believe a more defensive stance is still warranted at this time.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate.

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.

An index is unmanaged and not available for direct investment.

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The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information 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.

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