Global Equity Strategy

Weekly discussion of recent equity market action with equity sector highlights and what it may mean for investors.

September 27, 2016

Stuart Freeman, CFA, Co-Head of Global Equity Strategy
Scott Wren, Senior Global Equity Strategist

Conference Board Leading Economic Index—Near Cycle High

  • In August, The Conference Board’s Leading Economic Index (LEI) was more than one percent higher than in August of 2015 and near its high for this economic cycle.
  • Historically, this LEI level has often signaled more U.S. equity-market upside in the coming 12 months.

What it may mean for investors

  • Overall, we believe that the lower-for-longer status of inflation and interest rates should continue to provide stimulus for additional economic and equity-market growth.
speedometer reading of equities: large cap, mid cap, developed markets, small cap, and emerging-market.

Although The Conference Board’s LEI softened from 124.3 in July to 124.1 in August, the July reading was the high for the current economic cycle. The indicator sits near its cycle high. The high level in the prior cycle was 126 in March 2006. In recent cycles, the LEI has tended to move to meaningful new highs beyond the previous cycle's best level. (This also is the case for S&P 500 Index revenues and earnings.)

In August, four of the 10 indices within the composite were additive to the index while six were detractors.

Positive Contributors:

  • Interest-rate spread (between 10-year Treasury notes and the federal funds rate)
  • Stock prices
  • The Conference Board’s Leading Credit Index
  • Manufacturers’ new orders for consumer goods and materials

Negative Contributors:

  • Average weekly manufacturing hours
  • The Institute for Supply Management (ISM) new orders index
  • Average weekly initial claims for unemployment insurance
  • Manufacturers’ new orders for nondefense capital goods, excluding aircraft
  • Building permits
  • Average consumer expectations for business conditions

The breadth of the positive contributors, the diffusion index, was 40 (4 of 10) for August. This was the lowest diffusion index since the 30 experienced in February 2016. However, a diffusion index of 45 was registered in May of this year. Overall, the monthly data can be somewhat erratic; the six-month diffusion index was lower in May (at 30) than what was registered for the six months through August (45).

Chart 1. The Conference Board’s LEI: Year-to-Year Percent ChangeChart 1. The Conference Board’s LEI: Year-to-Year Percent ChangeSource: The Conference Board, FactSet, Haver Analytics, Wells Fargo Investment Institute, 9/26/16.

Overall, the LEI remains just below its high for this cycle, and is 1.1 percent higher than it was one year ago. Looking back to 1970, the average year-to-year change in the LEI was +1.8 percent (the median was +3.4 percent). Thus, the current one-year change is weaker than the longer-term average or median. However, from 1970 to today, when the one-year LEI change ranged between zero and 2.2 percent, S&P 500 Index performance has tended to lean to the upside over the following 12 months. Chart 1 shows the one-year change in The Conference Board’s LEI.

Based upon a total of 68 year-to-year instances for which the LEI increased by zero to 2.2 percent, the average percentage one-year forward change in the S&P 500 Index was +10.5 percent (with a median increase of +14.9 percent). In 54 cases (79 percent of total cases), the average forward 12-month increase in the S&P 500 Index was +18.0 percent (with a +17.6 percent median). In the other 14 cases (21 percent of total cases), the average forward 12-month change in the S&P 500 Index was-18.4 percent (a median decline of -15.5 percent).

Overall, we believe that the “lower for longer” status of inflation and interest rates should continue to provide stimulus for additional domestic economic and equity-market growth. Average weekly initial unemployment claims continue to point toward forward-looking job growth, and the housing market still appears healthy. While purchases of new homes fell from July levels in August, they had hit their highest levels of the cycle in July.

We are projecting roughly 6-7 percent earnings growth for the S&P 500 Index in 2017. That growth is expected to be driven by quality, cyclically-dependent companies. Our year-end 2017 target range projection for the S&P 500 Index is 2190-2290.

Weekly Wrap and Look Ahead

All major domestic and international indices were positive for the week and year to date.

Index Last Week’s Performance1 2016 YTD Performance
S&P 500 +1.2% +5.9%
DJIA +0.8% +4.8%
NASDAQ +1.2% +6.0%
Russell 2000 +2.4% +10.5%
MSCI EAFE +3.2% +2.9%
MSCI Emerging Markets +3.6% +18.1%
1. For the week of September 10 – September 23, 2016.
Source: Wells Fargo Investment Institute, Bloomberg, 9/23/16.

Six of the 11 S&P 500 Index sectors outperformed the Index. All 11 managed to gain ground on the week.

Best-Performing Sectors
Sector Last Last Week’s Performance2
Real Estate +4.3%
Utilities +3.4%
Telcom Services +1.9%
Worst-Performing Sectors
Sector Last Last Week’s Performance2
Energy +0.1%
Financials +0.4%
Materials +0.8%
2. For the week of September 10 – September 23, 2016.
Source: Wells Fargo Investment Institute, Bloomberg, 9/23/16.
Past performance is no guarantee of future results.

The typically volatile early September through mid-October period is holding up to expectations thus far in the domestic equity market (at least to some extent). Many investors had been lulled into thinking that the stock market was not going to do much in the latter half of the year after stocks nearly stood still in the wake of the post-Brexit rally. With that said, the S&P 500 is only 2 percent below the all-time record high set in late August (as of the time of this writing). When compared with other rolling 12-month periods over the past 32 years, performance divergence between sectors is extremely low (please see the September 1, 2016 Global Equity Strategy Report for more details).1

Yet, we continue to believe that there likely will be meaningful buying opportunities over the coming month or two as uncertainties surrounding the U.S. elections and European banks make investors nervous. The underlying economic fundamentals and our expectations for the resulting earnings growth are unchanged. We look for modest economic growth in the U.S. and 2017 earnings growth in the 6 to 7 percent range. We expect Energy-sector earnings to be a much lower drag on overall growth in the coming year.

This week’s presidential debate also will likely add to the volatility of recent weeks—as the polls show the two candidates neck-and-neck as we come down to the last six weeks or so before the November 8 election. We believe that, regardless of who is elected as president, the probability that he or she will be able to change the trajectory of the economy that is already in place over the first 12 (or even 24) months of their term is low. In addition, the next U.S. president likely will deal with at least a shallow recession toward the end of their first term—or certainly in a second term if reelected.

Sector S&P Weighting* Wells Fargo Investment Institute Guidance
Consumer Discretionary 12.4% Overweight 14.9%
Consumer Staples 9.9% Underweight 8.5%
Energy 7.0% Evenweight 6.5%
Financials 12.8% Evenweight 13.4%
Health Care 14.8% Overweight 17.2%
Industrials 9.7% Overweight 11.6%
Information Technoloy 21.2% Overweight 21.8%
Materials 2.9% Evenweight 3.0%
Telecom Services 2.7% Underweight 0.0%
Utilities 3.4% Underweight 0.0%
Real Estate Investment Trusts 3.1% Evenweight 3.1%
S&P 500 Earnings Estimate for 2016 $119.00
S&P 500 Year-end 2016 Target Range 2,190-2,290
*Sector weightings may not add to 100% due to rounding. Weightings as of 9/23/16 close. Targets are not guaranteed and may change.
Source: Wells Fargo Investment Institute, Bloomberg, 9/23/16.
Valuations and Fundamentals for Five Primary Equity Asset Classes Valuations and Fundamentals for Five Primary Equity Asset Classes*Enterprise Value.
Source: Wells Fargo Investment Institute, Bloomberg, 9/26/16. Developed Markets: MSCI EAFE Developed Market Index (Europe, Australasia, Far East). Emerging Markets: The MSCI Emerging Markets Index.

1 Global Equity Strategy Report, “Low Deviation between Returns Signals Upside Potential”, September 14, 2016.

Risk Factors

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.

The prices of small and mid-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.

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.


An index is unmanaged and not available for direct investment

The Conference Board Leading Economic Index is an index that is compiled by the Conference Board, a private-sector consulting firm. The index is a composite of economic measurements as was designed in an effort to track and forecast changing patterns in the economy.

The Conference Board Leading Credit Index is a composite index of financial indicators that contain many credit related financial indicators such as interest rate swaps, credit default swaps, certain corporate-treasury spreads, the Federal Reserve’s senior loan officer survey which help signal monetary and credit market conditions.

DJIA is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.

Institute for Supply Management Manufacturing Index (ISM) is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

NASDAQ is an unmanaged group of the 100 biggest companies listed on the NASDAQ Composite Index. The list is updated quarterly and companies on this Index are typically representative of technology-related industries, such as computer hardware and software products, telecommunications, biotechnology and retail/wholesale trade.

Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately eight percent 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 U.S. stock market. The Index is unmanaged and not available for direct investment.

Global Investment Strategy (“GIS”) is a division of Wells Fargo Investment Institute, Inc. (“WFII”). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by the GIS division of Wells Fargo Investment Institute. Opinions represent GIS’ opinion as of the date of this report and are for general informational 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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