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What it means to be eyes forward in the second half of 2019.
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In most asset classes, we suggest taking steps to maintain the strategic or long-term target allocation designed to achieve your long-term goals.
As markets rise, positions may need to be trimmed and cash held or reallocated to markets where valuations are better. As markets fall, the opportunity may arise to restore the target allocation.
Income is a sometimes-overlooked component of portfolio returns. To potentially improve the income-generating ability of a portfolio, you can lengthen the duration (a measure of a bond’s or bond portfolio’s sensitivity to interest rates) of your high-quality bonds (using a neutral overall duration and yield-curve profile). Dividend-paying stocks and real estate investment trusts (REITs) can also offer additional streams of portfolio income.
We view the current difference between the yields of lower-quality and higher-quality bonds as not worth the increase in default and market risk.
We expect markets to stay volatile. On rallies that take benchmark indices, (e.g., the S&P 500 Index) above our target levels, we suggest realizing some of the gains from U.S. equity holdings and placing the proceeds in cash–to await a better entry point in the coming months.
If a portfolio already holds a sizable amount of cash, there is no need to raise more; instead, investors should be prepared to invest cash should markets correct in the coming months.
Investing in international assets is an important way to diversify a portfolio. In recent years, U.S. equity markets have led global markets, but that trend may be changing. Currently, we are most favorable on emerging market equities.
Valuations in many emerging markets look attractive, and recent economic data point to stable economies in China and other developing countries.
Within U.S. equity markets, we favor sectors such as Information Technology and Industrials, areas of the market with higher-quality earnings.
A bear market can occur with little warning, so adding assets that can profit in both up and down markets may help prepare a portfolio for possible market downturns.
The hedge fund strategies we currently favor are equity hedge and relative value. Private equity and private debt may offer additional potential returns for long-term investors. These asset classes can provide access to innovative, fast-growing companies and to high-yielding debt.
Now may be a good time to begin building an allocation to private debt ahead of an eventual economic downturn that could provide fertile opportunities for distressed debt managers.
Alternative investments are not suitable for all investors and are only open to “accredited investors” or “qualified investors” within the meaning of the U.S. securities laws. They are speculative, highly illiquid, and designed for long-term investment and not as trading vehicles.
U.S. GDP growth
U.S. inflation Consumer Price Index
S&P 500 Index
Federal funds rate
10-year U.S. Treasury note yield
West Texas Intermediate crude oil per barrel
Source: Wells Fargo Investment Institute (WFII); June 11, 2019.
Forecasts and targets are based on certain assumptions and on our current views of market and economic conditions, which are subject to change.
The intelligent investor is a realist who sells to optimists and buys from pessimists.
Slow global growth, but no recession
The second half of 2019 should see positive growth of varying strength around the world.
Conditions globally should support continued economic growth, although with important regional differences.
Strong labor markets around the world should support personal spending, but business spending remains tepid while policy uncertainties persist.
While we expect softer global growth this year, a U.S. economic recession seems unlikely.
Major political uncertainties such as Brexit and trade disputes have tended to depress business confidence. We hope to see the resolution of some of these uncertainties later in 2019.
Sources: Wells Fargo Investment Institute, Markit, Bloomberg, and Baker, Bloom and Davis. Monthly data from January 31, 2006 to April 30, 2019.
Global economic slowdown periods defined by the Organisation for Economic Co-operation and Development (OECD). Policy uncertainty is represented by the Global Economic Policy Uncertainty Index produced by Baker, Bloom and Davis. It measures changes in news coverage about policy-related economic uncertainty, tax code expiration data, and economic forecaster disagreements. Business confidence measures the share of global manufacturing purchasing managers’ indices (PMIs) in expansionary territory (above 50). A PMI is a measure of dominant trends in manufacturing and is considered a leading indicator of economic activity.
Opportunities amid earnings growth and trade disputes
U.S. earnings growth will likely be slow but positive, and emerging market equity valuations appear attractive, but developed (ex-U.S.) international equities may pose risks.
We believe emerging market equities offer the highest return potential over the balance of the year.
We believe trade disputes involving the U.S. create headwinds for earnings growth, but low interest rates support most U.S. valuations at or above historical averages.
Investors who are not at their target allocations for emerging market equities might consider rebalancing from potentially over-allocated asset classes, especially small-cap equities.
As we move further through this long cycle, we want to focus on sectors that offer attractive quality characteristics, such as a high return on equity and low leverage.
Based on price/cash flow, emerging market equities currently trade at their most significant discount in years to U.S. large-cap equities.
Sources: FactSet and Wells Fargo Investment Institute. Monthly data from August 31, 1998, to April 30, 2019. Past performance is no guarantee of future results. An index is unmanaged and not available for direct investment.
The S&P 500 Index is an unmanaged index generally considered representative of the U.S. stock market. The MSCI Emerging Markets Index is a free-float-adjusted market-capitalization-weighted index that is designed to measure equity market performance of emerging markets.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
The implications of a Fed rate cut
Publicly the Federal Reserve (Fed) appears content to leave rates unchanged, but market participants are pricing in two or more rate cuts by year-end.
Interest rates are likely to remain relatively low through year-end.
Yield-curve inversion remains a risk. A meaningful inversion could foreshadow a more difficult economic environment.
We favor a neutral duration (duration is a measure of a bond’s or bond portfolio’s sensitivity to interest rates) stance because we view interest rate risk as limited through year-end.
We believe that investors should be selective and favor higher-quality issuers. For municipal bonds, we favor securities with dedicated revenue streams.
If we see the 1-year Treasury yield trading above the 10-year Treasury yield by 0.25% or for four consecutive weeks, we would view this as foreshadowing a more challenging economic environment.
Sources: Bloomberg and Wells Fargo Investment Institute. Weekly data from January 5, 1962 to May 15, 2019.
The difference between the 10-year and the 1-year Treasury yield measures the spread between short- and long-term interest rates. Shaded area represents timeframe of a U.S. economic recession. Yields represent past performance and fluctuate with market conditions. One hundred basis points equal 1%. Yields represent past performance and fluctuate with market conditions. Current yields may be higher or lower than those quoted above. Past performance is no guarantee of future results.
June 2019 Transcript