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Taking stock: Q3 equity outlook

Jun 28, 2019

Proceed with caution, but by all means … proceed. That is our message for equity investors as we assess the landscape for the third quarter. Highlights of our outlook include:

  • Although this cycle is old, we see no excesses to scare us away at the midyear point.
  • Valuations are elevated, but not overly demanding, and look attractive versus bonds. We advocate selectivity and portfolio resilience.
  • Wildcards to watch: U.S.-China relations, monetary policy and U.S. politics.

Equity market overview
and outlook

As we look to the third quarter, we believe stocks can grind higher ― even if not at the pace of the first half. The rebound from late 2018 losses has been evident across sectors. Yet the second quarter was not a straight line up. The S&P 500 Index lost 6.35% in May after having climbed 18.25% through April. The culprit: A breakdown in U.S.-China trade talks. We remain risk-on, but believe higher valuations, earnings uncertainty and an economic cycle approaching late stage argue for a focus on quality and selectivity in pursuit of portfolio resilience.

A Q3 watch list

What may influence market moves in the third quarter? We have three items on our watch list that may well bump earnings out of the driver’s seat ― for better or for worse:

U.S.-China relations: Markets had shifted into reverse after a May 5 tweet from U.S. President Donald Trump signaled trade talks with China had collapsed. High hopes for a deal quickly deteriorated to mutual mistrust between the two superpowers. We believe both nations have incentive to arrive at an agreement on trade. Yet the battle for global technology dominance is likely to rage on. The upshot: A trade deal, however modest, would be a positive for stocks in the near term, but expect a protracted cold period to generate headlines and market gyrations through time.

Monetary policy: The market is pricing in three rate cuts from the Federal Reserve over the next 12 months. Stocks and other risk assets have cheered the idea of a rate cut in the second half. The realization of a cut could give stocks a short-term boost. The medium-term question that market participants will begin to ponder is whether a rate-cutting cycle would be an insurance policy to keep the economy buoyant or, more worrisome, a defensive front to forestall a recession. A June 18 speech from European Central Bank President Mario Draghi suggested a renewed easing stance as well. The upshot: Look for a rate cut to boost stocks, but the subtext will be important to monitor for signs that late-cycle may be approaching recession.

D.C. politics: 2020 election campaigning kicks off this summer with the start of Democratic debates and rallies by incumbent Republican Trump. The agenda and rhetoric of the various candidates (with 25 hopefuls seeking the Democratic nomination) is sure to include proposals affecting the health care and technology sectors, where both public interest and regulatory scrutiny are high. The upshot: We like both sectors but believe a stock by stock approach is increasingly important.

Action item: Risk on and
risk aware

Across our fundamental active equity platform, a growing share of risk-taking budgets has been dedicated to stock-specific variables. An increased focus on idiosyncratic, company-level risks is one way to seek insulation from macro uncertainty. We also like companies with quality characteristics, including strong balance sheets and free cash flow, for their ability to boost portfolio resilience as the cycle ages.

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One thing I really like about this bull market: It has not been based on irrational exuberance but, rather, has climbed a wall of worry to reach current levels. Low conviction has limited any build-up of dangerous excesses and could imply there is room to go.

Tony DeSpirito
BlackRock Fundamental Active Equity Investment Team
Antonio (Tony) DeSpirito, Managing Director, is Director of Investments, U.S. Fundamental Equities. In addition, he is head of the U.S. Income & Value Team and is the ...