WEBVTT

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Since early February, investors have seen more
downside in equity prices than in all of 2017.

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But, this year's volatility was not a surprise to us.

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We had been expecting volatility to pick up
from last year's historically low levels,

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and the good news is that pullbacks
can actually be healthy for markets.

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Higher levels of volatility can signal building
risks, particularly late in business cycles.

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These risks can alter the risk-reward balance in portfolios.

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However, we believe positive feedback loops continue to
promote expansion as the rebound in corporate profits

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and sentiment should prove more durable in
promoting broad-based upturns in business spending

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and continued hiring through the remainder of 2018 and into 2019.

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To put it succinctly, late cycle doesn't mean end of
cycle — and that difference has investment implications.

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For example, the increased volatility in commodities, oil
in particular, was prompted by geopolitical uncertainties

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in the Middle East, stronger global oil demand,
and OPEC's unusually disciplined production cuts,

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all of which have pressured oil prices higher.

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Additionally, currencies have been more volatile this
year — foreign exchange markets price in the divergence

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between rising U.S. interest rates and the low rates that
persist in Europe, Japan, and other developed markets.

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While the U.S. equity markets got ahead of themselves in January,
we think earnings will continue to rise in an environment

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of steady economic growth and modestly
rising inflation and interest rates.

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That should support higher U.S. equity prices by year end.

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From a global standpoint, we favor U.S.
equities over developed and emerging markets.

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In fixed income markets, even gradually rising inflation

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and interest rates make long-term bonds
less attractive than short-term instruments.

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In comparing bonds across countries and regions, we
favor the U.S. over local-currency developed markets

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for two primary reasons — U.S. yields are more attractive
and we anticipate volatility in the currencies market.

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We would also be cautious on lower-rated areas of fixed income.

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At current valuations, we believe that high-yield debt
offers limited upside potential and meaningful downside risk.

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To lessen overall portfolio risk, we suggest moving up in
credit quality by reducing exposure to high yield bonds

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and investing in shorter-term high-quality corporate debt.

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We would also avoid commodity markets, where
we still see too much available supply.

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This indicates that investors likely will
see price declines as the year progresses.

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For more information, download our Wells Fargo
Investment Institute 2018 Midyear Outlook Report:

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Late Cycle Doesn't Mean End of Cycle.