Market Commentary

• In recent weeks, a number of market pundits have been calling for a more cautious approach to portfolio allocations.
• But based on our economic and earnings outlook for this year, we are not recommending that investors shift to a more defensive stance.

Financial news outlets over the long holiday weekend were fixated on recent stock and bond market volatility and questioning whether investors should be positioning more defensively looking ahead. That isn’t really anything new. In fact, in recent weeks, a number of market pundits have been calling for a more cautious approach to portfolio allocations as some of the more crowded (popular) trades in the market have either stalled, lagged the performance of the S&P 500 Index, or had a noticeable pullback. And all of this volatility has come as the “Street” has been boosting U.S. gross domestic product (GDP) and revenue growth estimates for this year.

Traditionally, a more defensively positioned portfolio would be less sensitive to the ebb-and-flow of the economy and usually hold up better when downside volatility occurs. Take for instance the Consumer Staples sector. Whether the economy is good or bad, consumers are going to buy shampoo, laundry detergent, and food. That is why they are considered staples and not discretionary items. The companies that provide those goods are in the Consumer Staples sector. Defensive sectors also tend to have modest growth rates and typically pay dependable dividends. We rate the Consumer Staples sector unfavorable.

Our regular readers know, and by now others may have surmised, that based on our economic and earnings outlook for this year we are not recommending that investors shift to a more defensive portfolio stance. Indeed, just recently, we boosted our U.S. economic growth rate to 2.9% (from the previous 2.4%), a robust pace for the world’s largest economy. We are leaning toward sectors and industry groups that are sensitive to and that we believe are likely to benefit from this increased level of growth. At the top of our recommended sectors list is Financials. Stronger economic growth typically leads to increased loan demand, more mergers and acquisition (M&A) activity, and more initial public offerings (IPOs), all services provided by companies in the Financials sector.

Another economically sensitive sector is Industrials. Our favorable recommendation here stems from not only a better overall economy but also the artificial intelligence (AI) infrastructure buildout segment of the economy. Building data centers and upgrading the electrical grid requires bulldozers, track hoes, electrical components, and many other goods produced by companies in the Industrials sector. Away from the AI buildout, a better economy would normally result in more building and other general construction activity that also requires the same type of machinery and components.

Note that we are also favorable on the Utilities sector, typically considered heavily defensive as no matter what the economy is doing, consumers will continue to turn on the lights, take a hot shower, and heat and cool their homes. But in this cycle, Utilities are tied to the AI trend as they will provide the energy for power-hungry data centers.

We would expect increased volatility after a strong multiyear run higher in stocks, especially when combined with a typically volatile midterm election year. In our view, pullbacks are opportunities to step into large- and mid-cap domestic equities in favored sectors. We do not favor defensive positioning.

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, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.

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. Consumer Staples industries can be significantly affected by competitive pricing particularly with respect to the growth of low-cost emerging market production, government regulation, the performance of the overall economy, interest rates, and consumer confidence. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. There is increased risk investing in the Industrials sector. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

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

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.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.

Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors.

Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company.