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Global Equities—Midyear Outlook

Wells Fargo Investment Institute - June 2017

Co-Head of Global Equity Strategy Sean Lynch discusses how now may be the time for investors to look for over-allocations in U.S. equities and reposition portfolios for what we believe could be better opportunities in Europe and Asian equities.

Transcript: Monthly Investment Outlook: Global Equities—Midyear Outlook

With the run-up in U.S. equity markets and the increased valuations in the first half of 2017, now may be a great time for investors to review their equity portfolios. We encourage investors to look for asset classes where they may be over-allocated and reposition for the second half of the year. For example, now may be the time for investors to look for over-allocations in U.S. equities and reposition portfolios for what we believe could be better opportunities in Europe and Asian equities.
First though, let’s take a look at U.S. equities. We expect stronger revenue and earnings growth for the S&P 500 Index. We believe the energy sector will not be a drag on earnings like it was the past two years, and a healthy consumer that should support growth in a variety of cyclical sectors, while expansion in developed international economies should benefit large multinational companies.
Despite positive earnings, we believe that the domestic bull market remains in its seventh inning, in large part because of valuations. Also, the Federal Reserve has begun to raise its key interest rate. Historically, as the Fed increases its interest rates, equity valuations tend to contract. In our view, that means U.S. equity prices are likely to be slightly lower by year-end. We believe domestic small-cap stocks are especially vulnerable to market pullbacks. We are not calling for an end to the bull market, but believe these markets may be range-bound for the rest of the year.
Developed and emerging equity markets have outperformed the main U.S. indices in the first five months of 2017.
In emerging markets, such as China and India, a dose of stability and incremental economic growth sparked outperformance in the first half of the year. We will be watching for additional earnings growth in emerging markets in the second half. One key risk factor will be the effect on international trade of the increased threat of protectionism coming from various parts of the world.
In developed markets, our forecast calls for earnings growth to drive market gains. We have seen earnings estimates improve across the developed markets, with the biggest increases in Japan and Europe. Yet, our target prices and outlooks imply limited upside for the international markets. Should we see a clearer path to even higher earnings, we may become more constructive on international markets.
International stocks have done better than U.S. stocks in the first half of 2017. However, U.S. markets outperformed international equity markets in four of the past five years. As such, many investors are heavily positioned in U.S. stocks. Recently, fundamentals have improved in many overseas markets, which could provide a tailwind for them. We believe investors should rebalance equity portfolios to avoid overweighting asset classes and sectors that have run higher since November. Our first place to target additional equity investments would be in the international developed markets, followed by the emerging markets.
In the United States, we favor large-cap equities over mid- and small-cap equities.  We remain underweight small-cap equities due to excessive valuations and earnings expectations.