State of the Markets

A look at what’s happening now and what may be ahead from Darrell Cronk, President of Wells Fargo Investment Institute.

Darrell L. Cronk, CFA, President of Wells Fargo Investment Institute

All Rise

Late May on the calendar brings rising levels of mercury on the thermometer along with rising anticipation of summer as we march into Memorial Day weekend. For the capital markets, the month of May has also brought its own ascension for many asset groups. We have witnessed rising equity prices, rising interest rates, rising oil prices, a rising U.S. dollar and rising trade and geopolitical tensions—all forcing markets to reassess their near term outlook.

Most concerning of late for investors have been the effects of rising rates and oil prices. The bond market convulsions are becoming increasingly frequent now as U.S. Treasury 10-year and 30-year yields recently hit levels unseen since 2014. Oil prices, after posting their longest run of weekly gains in seven years, continue their steady march higher on growing concerns over supply disruptions from the Middle East.

So far, any contagion has spared equities and rotated instead to currencies, emerging markets, and precious metals. Equity outperformance has remained reasonably pronounced as the U.S. economy continues to rebound from its first-quarter weak patch. The Atlanta Federal Reserve’s GDPNow model, a running estimate of real GDP growth, estimates second-quarter real GDP growth is now running at more than 4% and private fixed investment growth is tracking close to 6% growth, up from 2% last quarter.

The S&P 500 Index has outperformed the Bloomberg Barclays US Aggregate Bond Index by 5% so far during the second quarter. We’ve stayed favorable on U.S. equities and cyclicals versus defensives through both major bond market sell-offs this year because we thought stocks could handle higher rates as long as Federal Reserve policy remained accommodative and earnings growth strong. Also, since their market low in early February, U.S. small caps quietly have risen by double digits and have taken out their all-time high. Even more impressive is that, this quarter, the Russell 2000 Index (small caps) is beating the S&P 500 Index (large caps) by 7.5% as small caps tend to buffer investors against rising trade tensions and benefit from a larger drop in effective tax rates than their large cap peers.

What else is on the rise? We believe the dual fiscal stimulus packages from December’s tax reform and the sizable spending budget passed in January by Congress are both having much-anticipated positive effects. Signs of corporate purse strings being unleashed are evident in the most recent data. The first quarter of this year saw the fastest start on record for merger and acquisition activity, which has surged $473 billion, up 68% year over year. S&P 500 dividend growth also spiked to a three-year high; last quarter was the first quarter since 2003 with literally zero dividend cuts within the index. U.S. share buyback authorizations for S&P 500 companies also jumped $205 billion, or 48%, year over year last quarter. And finally, we’re seeing early signs that capital expenditure (Capex) spending by companies is tracking well above expectations and is likely to further accelerate in the second half of this year. All we believe are positive signs that sturdier economic growth lies before us through the remainder of 2018 and into 2019.

Memorial Day weekend is the unofficial start to summer. We stroll into this summer in a good place with rising profits, rising employment and rising consumer and business spending and confidence. However, the title of this update is not just about market and economic variables. Memorial Day is a call of remembrance to pay tribute to those who died in service to their country. There can be no greater sacrifice. We owe a great gratitude to all who served for their dedication and bravery. May we have the courage to do our duty as well as they have done theirs. All Rise.

Risks Considerations

Past performance is no guarantee of future results.

All investing involves risks including the possible loss of principal. Each asset class has its own risk and return characteristics which should be evaluated carefully before making any investment decision.

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. There is no guarantee dividend-paying stocks will return more than the overall market. Dividends are not guaranteed and are subject to change or elimination. The prices of small-cap company stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.

Definitions

Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond 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.

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.

Wells Fargo Investment Institute, Inc. (“WFII”) is a registered investment adviser and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

Wells Fargo Wealth and Investment Management, a division within the Wells Fargo & Company enterprise, provides financial products and services through bank and brokerage affiliates of Wells Fargo & Company. Brokerage products and services offered through Wells Fargo Clearing Services, LLC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company. Bank products are offered through Wells Fargo Bank, N.A.

Abbot Downing and the Private Bank provide products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries. Wells Fargo Institutional Retirement & Trust is a business unit of Wells Fargo Bank, N.A.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

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