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Monthly Investment Outlook: U.S. slowing down

Wells Fargo Investment Institute - August 2022

Presenter: Scott Wren, Senior Global Market Strategist, Wells Fargo Investment Institute

Transcript:

Our analysis suggests that after economic contraction in the first and second quarters of 2022, the U.S. economy’s deterioration is likely to continue into early 2023. Housing and business capital spending plans
are two examples of key domestic economic segments whose outlooks have dimmed as the Federal Reserve aggressively hikes interest rates and inflation wreaks havoc on consumer’s wage gains. We now expect a moderate recession to begin soon and last until the middle of next year.

But we are already in what some would consider to be a technical recession, defined as two consecutive quarters of economic contraction. Historically, over the past 75 years, a technical recession has been a reliable indicator of an eventual “official” recession — as declared, usually in hindsight, by the National Bureau of Economic Research. At the very least, it is safe to say growth in the first half of this year shows the U.S. economy has little forward momentum.

Higher-for-longer inflation and the synchronized tightening response from many of the major (and minor) global central banks have taken a toll on equity valuations as well as consumer and business confidence.
The economy is slowing quickly based on our analysis of the data. Earnings headwinds have been more pronounced in the second quarter and overall guidance has been adjusted to the downside. Based on these expectations, we recently lowered our 2022 earnings estimate for the S&P 500 to $200, down from $220.

With lower valuations and earnings estimates, we now expect the S&P 500 Index to finish the year in the 3800-4000 range. We do expect to see economic improvement as we move through 2023 as the worst of the recession will likely occur late this year. By mid-2023, we expect brighter skies to be on the horizon, as the Federal Reserve will likely have halted its tightening process and interest rates fall back in response to more modest economic growth and lower inflation.

While many investors may be nervous, we do not favor selling into the current weakness. The U.S. and global economies may go through a rough patch in coming quarters, but history has shown that the bottoming process in financial markets can often take time. Those investors who have funds on the sidelines can patiently and incrementally take advantage of downside volatility to put money to work and potentially benefit from the rebound that we believe may occur next year.

We recommend incrementally putting sidelined funds to work in the equity market. We favor U.S. over International, larger cap over smaller cap, and have taken a more defensive posture in terms of sectors by favoring Health Care, Technology, and Energy. We are also playing defense in fixed income and favor exposure to short-term fixed income. Alternative strategies we favor include macro and relative value. For now, we are more focused on capital preservation over capital appreciation.