Market Commentary

• At its worst point in last week’s trading, the S&P 500 Index (SPX) was down approximately 3% from the late-January record high.
• But to many investors it might have felt far worse than that as the financial media was laser-focused on some of the worst-performing segments of the market.

While investors are generally fond of equity markets that trend steadily to the upside, the reality is the stock market is volatile and susceptible to stumbles and turmoil at multiple points along the way in most economic cycles. The trick is to figure out whether an episode of downside price action is an opportunity to buy or an indication that fundamentals are deteriorating and there might be more to come.

Much of what determines whether a pullback is a potential opportunity is the forward outlook when the correction occurs. What are the prospects for economic growth and corporate earnings? And what about inflation? Is the Federal Reserve (Fed) likely to take action to stem any potential rise in the general price level or can investors expect cost pressures to subside, which just might allow the U.S. central bank to cut rates? Note that our outlook calls for moderate growth, moderate inflation, and further Fed easing over the course of this year. In fact, last week we increased our U.S. economic-growth estimate for this year to 2.9% from 2.4%. Under these expected conditions, we think equity corrections can be buying opportunities.

Another step to take when looking at potential market opportunities sparked by a pullback is to examine what is going on “under the hood.” In other words, are stocks broadly down or is the selling concentrated in certain sectors or industry groups? At its worst point in last week’s trading, the SPX was down approximately 3% from the late-January record high. To many investors it might have felt far worse than that as the financial media was laser-focused on some of the worst-performing segments of the market, like software stocks. We favor a market-weight allocation to the Information Technology and Communication Services sectors while investors reset their expectations for valuations in these sectors.

But there were some positives last week despite all the negative headlines. For example, the Dow Jones Industrial Index traded over 50,000 for the first time — a new record. And one we closely watch, the S&P 500 Equal Weight Index, also traded to a record high as performance broadened beyond just technology and tech-like companies. Broader participation in up markets is typically better. Also consider that the Russell 1000 Index of large-capitalization stocks closed last week near its record high.

And are you aware that the stock market has been rotating toward sectors that are value-oriented and cyclical? From a high level, that means money is moving toward sectors that are sensitive to the ebb-and-flow of the economy. When the economy does better, cyclical and value sectors have tended to do better. Since the middle of October, the three best-performing sectors have been Energy, Materials, and Industrials (a favored sector). These sectors have performed much better than the SPX and are very sensitive to the underlying economy. As we have been saying since December, the strengthening economy that we expect should benefit a broader group of market sectors. Looking through the hand-wringing of the headlines remains our guidance.

Forecasts and targets are based on certain assumptions and on views of market and economic conditions which are subject to change.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility.

Dow Jones Industrial Average is an unweighted index of 30 "blue-chip" industrial U.S. stocks.

Russell 1000 Index measures the performance of the 1,000 largest companies in the Russell 3000 Index, which represents approximately 90% of the total market capitalization of the Russell 3000 Index.

Russell 3000 Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the U.S. stock market.

S&P 500 Equal Weight Index is the equal-weight version of the widely-used S&P 500. Instead of weighting companies by market capitalization, each of the 500 companies gets the same weight (0.2% each).

An index is unmanaged and not available for direct investment.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

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