Institute Alert

• The S&P 500 Index fell 2.7% on October 10, the most in six months, after China and the U.S. sharpened their trade negotiation rhetoric.
• China threatened export controls on essential rare earth metals and the U.S. replied with the threat of 100% tariffs on Chinese imports.
• The rhetorical escalation came as Wall Street expectations for tech spending, tariff adjustments, and hiring have risen to justify the 31.50% rally between April 8 and October 10.
• Overseas markets and U.S. equity futures rebounded over the weekend as both sides urged further negotiations, but we expect financial markets to remain sensitive to news in the coming weeks.

• China and the U.S. appear to be testing their leverage for coming negotiations, but what is most notable is the reflexive equity market reaction.
• The sensitivity to trade and other issues may continue in the coming weeks of the third-quarter earnings season: Expectations are high for earnings growth, and investors also likely will focus on forward guidance around further tech spending and tariff adjustments. Also, while the government shutdown continues, any plans for hiring or layoffs could move currency, interest rate and equity markets.
• As for tariffs, our work indicates a gradual and selective passthrough of tariff price hikes to retail customers but a more extensive passthrough at the business-to-business level.
• We anticipate a broader passthrough to consumer goods as companies adjust to the levies, but we expect limited impact on inflation and economic and earnings growth.
• Other trends, already in place, that we see working more positively in our investment guidance through 2026, include tech spending momentum, a resilient economy, borrowing costs that we expect to fall further, deregulation, and meaningful tax cuts.
• The S&P 500 Index is in an uptrend. There is price support at the 50- and 200-day moving averages of 6530 and 6050, respectively.

• Heightened market sensitivity to news during this third-quarter earnings season could produce sudden pullbacks, because investors appear to want regular reassurance after the past six months of mostly steady price gains.
• We emphasize looking through the noise of tariffs to find the signal, that is, those positive trends already in place. To reiterate: deregulation, extensive tax cuts for businesses and households, a trajectory for further Federal Reserve (Fed) interest rate cuts, and a solid trend for further tech spending.
• Our S&P 500 Index target range midpoint for the end of 2026 remains 7500, based mostly on earnings growth from these positive trends.
• We see significant cash on the sidelines and believe that investors are waiting for pullbacks to put liquidity to work. We will continue to look for long-term opportunities as attractive valuations appear.

In fixed income, we expect diminishing return opportunities in short-term securities while the Fed is cutting interest rates. We also foresee potential risks to long-maturity fixed income returns. At this time, we prefer intermediate-term (3-7 year maturities) in investment-grade corporate and municipal fixed-income securities, to lock in higher yields than short-term securities will offer and with less return volatility than long-dated maturities.

Following a mild economic slowing we expect from tariff impacts into early next year, the positive trends mentioned above should drive stronger economic and earnings growth. We prefer U.S. Large Cap and Mid Cap Equities over U.S. Small Cap Equities. We prefer a similar lean toward quality in international equities, where we hold a neutral rating on Developed Market ex-U.S. and an unfavorable rating on Emerging Market Equities.

Within equity sectors, we prefer more cyclical and artificial intelligence (AI)-oriented sectors over consumer and most defensive ones. Financials will likely benefit from a steepening yield curve and deregulation. Information Technology and Industrials should benefit from AI spending, as should Utilities, departing from its traditional defensive role.

Our unfavorable sectors include the typical cast of defensive characters: Consumer Staples and Health Care that are likely to underperform as stocks move higher. We are also unfavorable on the Consumer Discretionary sector as tariffs ratchet higher and lower-income consumers continue to struggle.

Volatility due to tariff uncertainties and other issues, as well as the onset of third-quarter earnings season may continue in coming weeks. We recommend using market pullbacks as an opportunity to rebalance funds toward our favored asset classes and sectors. The goal of rebalancing is to reduce exposure where prices have become the most extended and to recycle the proceeds into potentially better values. In this way, rebalancing seeks to reduce near-term risk and to look for new potential opportunities as markets enter a likely volatile period.

Forecasts and targets are based on certain assumptions and on views of market and economic conditions which are subject to change.

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. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. 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. Municipal bonds offer interest payments exempt from federal taxes, and potentially state and local income taxes. Municipal bonds are subject to credit risk and potentially the Alternative Minimum Tax (AMT). Quality varies widely depending on the specific issuer. Municipal securities are also subject to legislative and regulatory risk which is the risk that a change in the tax code could affect the value of taxable or tax-exempt interest income.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

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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