January 3, 2019
Darrell L. Cronk, CFA, President of Wells Fargo Investment Institute
Five New Year’s Resolutions For Markets
2019 begins with markets fixated on a myriad of key risks for this year. Through the holidays, I was asked many times: What would reinstate confidence and put the markets back on a steady path forward to continue this expansion cycle? I would propose five New Year’s resolutions that could certainly help.
- A pause by the Federal Open Market Committee (FOMC) in raising rates: A 50-year low in the unemployment rate, growing wage pressure, and core inflation running close to the Federal Reserve’s (Fed) 2% target certainly give the Fed justification to continue to raise rates. Following the combination of four hikes in 2018, continued balance sheet reduction, and the tightening effects of a strong U.S. dollar, markets could benefit from a pause to allow their delayed effects to take hold. We still believe the Fed is not done raising in this cycle, but a pause during the first part of 2019 would give relief to markets that a policy mistake is not imminent.
- A de-escalation of China trade tensions from Beijing and Washington: While a full blown trade deal may be too much to ask, forward progress on bringing down trade tensions would not be. We believe, as China economic data weakens and the current U.S. administration attempts to ramp up growth heading into the 2020 election year, that the conditions are favorable for the U.S. and China to make progress on key parts of their trade relationship.
- More capital spending from corporate CEOs: Capital expenditure (capex) growth in 2018 for S&P 500 Index companies was close to 6%—above trend for the cycle, but certainly not as robust as anticipated coming off a historic reduction in tax rates, 20% profit growth, and unlocked overseas cash from repatriation. Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) have favored financial engineering through corporate share buybacks and dividends. We believe the markets would welcome a more consistent balance in 2019 between financial engineering and stronger capital spending, as a way to reinforce rising corporate efficiency and help extend earnings growth and the cycle.
- Pro-growth policies out of European leaders: Confidence and growth in Europe have been lacking since the last financial crisis in 2008-09. The latest round of escalating risks—ranging from Brexit, Italian budget concerns, and French protests—only continue to exasperate investors’ patience and conviction. Equity valuation differences between the U.S. and Europe, arguably the two most developed economies in the world, remain at multi-decade highs, creating compelling longer-term value. Committing to comprehensive, coordinated pro-growth economic policies across the continent would mark an important inflection point if European leaders can find the political will.
- Broader equity sector leadership beyond technology: It has been no secret that technology has been the darling outperformer throughout the entire cycle, often at the investor expense of other equity sectors. Six of the 11 sectors finishing last year with double-digit negative returns notwithstanding, U.S. equities saw impressive overall profit growth. A broadening of equity sector participation in 2019 would be a healthy sign, as a number of sectors look oversold and represent some compelling value. Financials and Industrials are our highest conviction ideas.
2018 proved to be a challenging year—almost every asset class finished in the red after beginning last January with the strongest absolute and risk-adjusted returns for equities on record. Even bonds, while certainly providing valuable diversification benefits, failed to deliver positive returns across almost all categories as 2018 marked a sizable year of outflows from fixed income. Investors would be justified in being disappointed in their returns, given strong U.S. gross domestic product (GDP) growth of almost 3% and U.S. profit growth exceeding 20%.
We do believe 2019 will prove a better year; the pendulum has swung too bearish relative to fundamentals, in our opinion. Keep your eyes on these five 2019 New Year’s resolutions. Any progress, individually or collectively, would be welcomed by the markets and, we believe, could arrest the latest sizable turn down in risk assets.
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