Market Commentary

Weekly commentary on recent stock market action, with a particular focus on technical analysis.

July 19, 2017

Scott Wren, Senior Global Equity Strategist

Focus on Federal Reserve Action in 2018, Not 2017

  • Recently, the stock market has been reacting positively to economic indicators that are coming in below expectations. The market has crawled higher as investors have hoped the Federal Reserve (Fed) may slow the pace of rate hikes in 2018.
  • We recommend staying invested even though we see the major indices modestly lower at year-end 2017. We do not believe the cycle is coming to an end. We believe investors should continue to focus on the more cyclical sectors of the market such as Consumer Discretionary, Industrials and Financials. Based on our preliminary analysis, we continue to believe the S&P 500 will be higher than current levels at the end of 2018.

The stock market, ideally, is a gauge of future expectations. It is considered a leading indicator. The performance of the S&P 500 Index is one of 11 components of the Conference Board’s Leading Economic Index (LEI). Of course, no leading indicator that we know of is right 100 percent of the time. But, we believe a leading indicator is of far more value than an economic report that tells you what happened in the past (a lagging indicator) or what is happening now (a coincident indicator). We spend quite a bit of time trying to predict what various leading indicators will do in the future.

However, as most grizzled equity investors know, the stock market can be a false (or just downright wrong) leading indicator in some instances. An old market bromide goes something like this: “The stock market has predicted nine of the last five recessions.” Depending on whom you talk to, the numbers might be a little different, but the meaning is the same. Stocks can oftentimes get caught up in the (human) emotion of the moment and act in ways that have nothing to do with the current fundamentals or (in hindsight) what the actual fundamentals end up to be down the road. This is especially true on panicky market moves to the downside. Most, if not all, of the other 10 components in the LEI do not give nearly as many “false” signals of future economic activity as the stock market. Once again, it is the human emotion factor that differentiates the stock market from most of the other leading indicators.

But the bottom line is the equity market tries to look ahead. Right now, we believe market participants are pretty convinced the economy is locked into a modest growth/modest inflation pattern that is unlikely to change any time soon. And if you look at the recent yield on the 10-year Treasury note, it appears the bond market thinks that four more Fed interest rate hikes between now and the end of next year will not allow economic growth or inflation to meaningfully accelerate. The financial markets also seem to be pricing in another rate hike this year and the potential start of the long, long process of the Fed slowly trimming the size of its $4.5 trillion balance sheet.

So it appears the stock market is comfortable with what we believe is likely to happen over the balance of 2017. What the stock market is now beginning to hone in on, at least in this strategist’s opinion, is what our central bankers will actually do with rates next year. Are three hikes really on the table, or will there actually be just one or two when 2018 is over and done with? Investors are already looking at economic reports and attempting to divine how they might affect the pace of distant hikes. The stock market is sensitive to Fed comments that hint about next year’s anticipated rate hikes.

Low interest rates have been a big factor in the equity market rally during this recovery. Next year’s Fed action will be key. That is why the stock market is focused on potential Fed action in 2018, not 2017.

Risk Factors

No forecast is guaranteed and is subject to change.

All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.

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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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