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Weekly Investment Commentary: Stocks rise as they shrug off geopolitical risks
Highlights
- Stocks have started off strong in 2020, as investor confidence levels remain high.
- We think investors may be looking past such risks as possible corporate earnings disappointments and lingering issues in the manufacturing and trade sectors.
- As a result, we believe equity markets may be due for a near-term consolidation or correction.
The world and market attention last week was focused on the U.S. strike against Iran and mounting tensions in the Middle East. Yet markets largely looked past geopolitical risks and started 2020 on a strong note.1 For the week, the S&P 500 Index rose 1.0%, with technology, communication services and health care leading the way.1 Energy, financials and industrials were the biggest laggards.1
Weekly top themes
- The December employment report was “good enough” for investors. While hiring slowed slightly, wage growth is not accelerating, which is good news for corporate profit margins.2 Additionally, a lack of strong wage growth would help keep inflation relatively muted, meaning the Federal Reserve has ample reason to remain on hold.
- Long-term jobs growth is slowing, but that shouldn’t mean the end of the current expansion. In 2018, average monthly jobs gains were 223,000.2 That slowed to 176,000 last year.2 But we think the interest rate cuts from 2019 are just starting to stimulate areas of the economy such as manufacturing.
- We are closely watching inflation risks in 2020, but for now they appear absent. If anything, we see slight downward pressure on inflation right now coming from increased global competition and technological advancements.
- Rising tensions between the U.S. and Iran represent a possible risk, but markets have a history of looking past geopolitics. The situation could, of course, worsen, but we think a negotiated outcome is more likely than continued escalation.
- U.S./China trade is unlikely to make much additional progress, but trade should be less of a risk in 2020. We see little chance of a phase-two trade agreement before the U.S. elections. But we expect less of a push for new tariffs and trade restrictions.
- This decade-long economic expansion has been very slow, and could continue. Since the financial crisis, households and businesses have approached spending and investing cautiously, which has caused a slow and prolonged expansion. Today, we are not seeing the imbalances that would suggest the expansion is ending.
- Corporate earnings could represent a risk in 2020. Stock prices have been rising for the last several months, even as corporate earnings expectations have been falling. In our view, expectations for 2020 may still be too high, which could put equity prices at risk.
Equities may be in for a bumpy ride in 2020
Six months ago, fears of a possible recession surfaced due to falling manufacturing levels, acute trade concerns and an inverted yield curve. Sentiment has improved markedly since then, and the second half of 2019 saw strong gains for equities and other risk assets.
2020 has started in a risk-on mode with investors, despite a short-lived setback in stock prices and a spike in oil related to rising U.S./Iran tensions. Investors largely shrugged off rising tensions in the Middle East, evidence of a more mature investment cycle as investors seem increasingly confident. Investors don’t seem over-confident at this point, with neither a recession nor tighter monetary policy on the horizon, but we do think they may be looking past ongoing risks.
For most of the past decade, we have adopted a persistent bullish stance toward the economy and equities. But today, we are less enthusiastic about the outlook for corporate earnings and profits and think markets may be overbought. Likewise, we see signs of improving manufacturing and trade levels, but this progress is marginal and these areas of the economy continue to represent a source of possible risk. We don’t expect much additional progress on the U.S./China trade front before the U.S. election, and business investment levels will likely remain muted as trade uncertainty continues.
As a result, we think stocks are likely to enter into a consolidation or correction phase in the near future, especially considering their strong rally over the past several months. Nonetheless, important factors like low bond yields, supportive central bank policy and improving economic growth are supporting equity prices. But in the end, we think markets as a whole will likely generate only modest returns this year and near-term risks are elevated.
We think stocks are likely to enter into a consolidation or correction phase in the near future, especially considering their strong rally over the past several months.
1 Source: Bloomberg, Morningstar Direct and FactSet.
2 Source: Bureau of Labor Statistics
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy.
Risks and other important considerations
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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