This blog post originally ran as an Institute Alert by Darrell Cronk, CFA, President, Wells Fargo Investment Institute and Chief Investment Officer, Wealth and Investment Management; Paul Christopher, CFA, Head of Global Market Strategy; and Sameer Samana, CFA, Senior Global Market Strategist.

Key takeaways

  • The sell-off that started in October has resumed recently after a brief respite in early November.
  • The economy still appears solid, and we believe this is not the end of the economic cycle or the bull market.

What it may mean for investors

  • We believe investors should continue to fight the urge to overreact to negative headlines and instead focus on implementing their investment plans. We also recommend considering increasing equity exposure selectively, especially by deploying cash.

The sell-off that started in October has resumed recently after a brief respite in early November. A variety of factors are bothering markets, and this report considers the main influences and what investors may want to focus on:

  1. Trade war – Further U.S.-China tensions at the recent Asia-Pacific Economic Cooperation summit led market participants to dial down their expectations for the upcoming G-20 meetings later this month. A deal on trade is more likely in early 2019, but probably not until after another round of tariffs is implemented. That being said, we don’t believe a full agreement is needed at this time, but a high-level understanding and a handshake between the two countries’ presidents to resume talks and not escalate tariffs further would be a good first step.
  2. Fed tightening – One of the main market concerns is that the Federal Reserve (Fed) will make a policy mistake by raising interest rates too fast. This difference of opinion in how quickly to raise interest rates can be seen in financial markets, which expect only two hikes in 2019, while the latest survey of Fed policymakers suggests four potential hikes. However, recent Fed speakers have already softened their tone a bit, but markets seem unable to give them the benefit of the doubt. We believe investors may see in the coming months that the Fed is not on autopilot and won’t exceed the neutral rate blindly—instead, it will stay flexible and data-dependent.
  3. Oil price declines – Crude oil’s slow and steady ascent during the first nine months of 2018 and the subsequent crash over the last six weeks is one of the more remarkable market reversals this year. Investors are concerned that the price of oil might point to a global growth slowdown. We believe that much of the decline was due to oversupply, rather than slowing demand, and that a price rebound is likely. The stability we foresee in the price of oil should further help to repair sentiment. The December 6 OPEC (Organization of Petroleum Exporting Countries) meeting is an important catalyst for oil markets, although we believe Saudi Arabia is capable of balancing 2019 oil markets on its own.
  4. China slowing/global slowdown – China’s economy has been slowing this year, mainly from the impact of financial reforms. As China showed in 2015-2016 during its last round of significant reforms, the government is committed to economic stability, and willing to provide stimulus if growth slows by too much. The current slowdown is less extreme than in 2016, but Beijing has already implemented a wide range of stimulus measures: a weaker currency and various measures to spur bank lending. Beijing also could rein in the reforms, if necessary. However, markets may remain uneasy until China’s stimulus measures gain traction (probably early in 2019).
    Meanwhile, European political problems are creating new stress. If Britain’s parliament approves a proposed Brexit deal in early December, markets could see significant relief; a failed vote in parliament would add to market worries. Italy’s budget challenge to Brussels also is likely to become noisier in the coming weeks.
  5. Technology selloff – Recent earnings reports and cautious guidance about future business prospects have caused an abrupt selloff in Technology. Also, concerns over extended valuations, more regulatory scrutiny/oversight, and peak earnings growth have created a difficult near-term outlook for many tech companies. The sharp decline in valuation multiples during the pullback should lessen some of the concerns about valuation and the worst of the sell-off may be over.

We still see a solid U.S. economic outlook—just in the last week we have seen good data on small business optimism, consumer confidence, retail sales, and industrial production. But concerns about a global growth slowdown are pulling down strong U.S. growth and investor sentiment. Still, the bottom line, in our opinion, is that an economic recession is not imminent—even as many areas of financial markets are pricing like we are heading for one.

When market sentiment turns so negative, stock price levels make a difference in the near-term outlook. We would become more concerned if the S&P 500 Index breaks below price levels that have been supports during selling episodes earlier this year. Those important support levels include the October 2018 lows (2640-2655) and the lows from the first quarter of 2018 (2581-2605).

What should investors do now?

Keep perspective: We believe investors should continue to fight the urge to overreact to negative headlines, and instead, focus on implementing their investment plans, which should include asset allocation, diversification, and rebalancing as core components.

Look for opportunities in equities: As we wrote in October, market action this year probably marks the end of the unprecedented period of low volatility and above-average returns across equites, fixed income, and currencies.1 Yet, the economy still appears solid, and we believe that this is not the end of the cycle or the bull market. We view now as a time to be ready to increase equity exposure in favorable areas, such as U.S. large-cap, U.S. mid-cap, and emerging-market equities, and favor deploying cash now—or even allocating incrementally over the coming days and weeks. In our opinion, current conditions have the potential to create some of the best entry points into equity markets since the November 2016 elections.

1 Please see our report, Institute Alert, “Opportunity Amid the End of Easy,” October 15, 2018.

Risk Considerations

All investing involve risks, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors some of which may be unpredictable. Each asset class has its own risk and return characteristics which should be evaluated carefully before making any investment decision. 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. Asset allocation and diversification do not guarantee investment returns or eliminate risk of loss. Stock markets may fluctuate in response to general economic and market conditions, the prospects of individual companies and industry sectors. Mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. 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.


General Disclosures

The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value-weighted index with each stock’s weight in the index proportionate to its market value. You cannot invest directly in an index.

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 Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by GIS. 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.

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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