This blog post originally ran as a State of the Markets commentary by Darrell Cronk, CFA, President, Wells Fargo Investment Institute and Chief Investment Officer, Wealth and Investment Management

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.

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.

Darrell L. Cronk is the president of Wells Fargo Investment Institute, which is focused on delivering the highest quality investment expertise and advice to help investors manage risk and succeed financially. Mr. Cronk leads global investment strategy and research including equity, fixed income, real assets, and alternative investments. He also serves as chief investment officer for Wealth and Investment Management, a division of Wells Fargo & Company that includes Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement & Trust, and Abbot Downing.

Risk Considerations

Each asset class has its own risk and return characteristics.  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. 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. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.

Index Definition

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.

General Disclosures

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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