Corrections Do Not Equal Recessions

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1 Craig P. Holke Investment Strategy Analyst WEEKLY GUIDANCE ON ECONOMIC AND GEOPOLITICAL EVENTS Corrections Do Not Equal Recessions November 6, 2018 Key takeaways» When equity markets correct, fears may arise that the end of the cycle is near. Yet, equity market corrections occur frequently and do not signal impending doom for the economy.» We believe that the U.S. economy remains strong. The consumer continues to be optimistic, supported by the strongest labor market in decades, and spending more than offsets current areas of concern, such as the slowing housing market and trade. What it may mean for investors» When forward-looking economic and equity fundamentals are solid, we believe that corrections often can offer compelling buying opportunities. The recent equity market correction has led to concerns that the U.S. economy may be nearing the end of the cycle and facing an imminent recession. Although markets are forward-looking by their very nature, at times, other events capture their attention. The most recent correction has not been the most significant since the Great Recession. While the equity sell-off may have been attributable to a number of concerns investors have, we do not believe that it reflects the threat of recession in the near term. The U.S. economy is growing at a solid pace. We expect growth to continue moderating from the strong second-quarter growth rate of 4.2%, yet we do not anticipate a recession in The U.S. economy remains solid Independent of the market reactions to higher interest rates, increased tariffs with China, or the threat of slower global growth, the U.S. economy continues to expand at a solid pace. Economic growth is being supported by the strongest labor market in decades. Payroll growth remains solid, and jobless claims are near levels last seen in the 1960s. The strong labor market, helped by tax reform, has consumer sentiment at 18-year highs. This has encouraged the consumer to increase spending and drive economic growth higher. Prior to the sharp drop in September, business investment had been growing year-over-year (YoY) at the fastest pace since The federal government budget passed earlier this year is a source of growth and is expected to remain so through Inflation remains moderate. Growth in prices had almost hit 3.0% YoY in July, until it fell as unfavorable YoY comparisons faded Wells Fargo Investment Institute. All rights reserved. Page 1 of 5

2 Even with solid economic growth as the backdrop, equity markets do tend to correct over time. A correction is generally viewed as a decline of 10% or more from a recent index high. Concerns over a number of items (e.g., central bank policy, trade relations, and wage growth) that change investors outlook for equity performance may drive corrections. They are not always driven by the underlying economic or company fundamentals. Table 1 details corrections for the S&P 500 Index for the current (and prior two) cycles. Table 1. Corrections do not lead to imminent recession Beginning of correction End of correction Decline in S&P 500 Index Months until recession October 3, 2018 October 29, % 1? January 26, 2018 February 8, %? May 21, 2015 February 11, %? April 29, 2011 October 3, %? April 23, 2010 July 2, %? Great Recession (December 2007 June 2009) November 27, 2002 March 11, % 57 Recession (March 2001 November 2001) July 16, 1999 October 15, % 17 July 17, 1998 August 31, % 27 October 7, 1997 October 27, % 36 Source: Wells Fargo Investment Institute; October 31, The data displays the beginning and end of each correction as of market close, along with the decline in the S&P 500 Index over that time frame. It then calculates the number of months until the next recession as determined by the National Bureau of Economic Research (NBER). The most recent correction is the smallest of the five we have had during this cycle. Yet, the last two have occurred over the shortest period of time, amplifying the stress felt by investors. Examining previous cycles shows that there is usually a prolonged period of time between the last correction and an eventual recession. As we approach this economic cycle becoming the longest on record next year, this may not even be the last correction experienced. 1 The S&P 500 Index crossed the 10% threshold for a correction on an intraday basis before it closed down -9.7% Wells Fargo Investment Institute. All rights reserved. Page 2 of 5

3 Market implications Equity market corrections historically are relatively frequent, and they are signs of normal market activity. While there are some areas of concern in the U.S. economy, such as the housing market, we believe that economic fundamentals are likely to remain strong, and corrections may offer buying opportunities. We view the recent correction as offering such an opportunity. We discussed this view in our recent report Opportunity Amid the End of Easy. 2 Volatility likely will increase as markets digest slower earnings growth, less robust equity growth, and continued geopolitical uncertainty. We believe that there is opportunity for solid equity market gains near the end of the cycle, and our research leads us to believe that the current cycle still has room to run. 2 Opportunity Amid the End of Easy, Darrell Cronk, Institute Alert, Wells Fargo Investment Institute, October 25, Wells Fargo Investment Institute. All rights reserved. Page 3 of 5

4 Economic Calendar Date Country Report Estimate Previous 11/6/2018 GERMANY Factory Orders MoM -0.50% 2.00% 11/6/2018 JAPAN Labor Cash Earnings YoY 1.10% 0.90% 11/6/2018 US JOLTS Job Openings /7/2018 ITALY Retail Sales MoM -0.20% 0.70% 11/7/2018 JAPAN Core Machine Orders MoM -9.00% 6.80% 11/7/2018 US MBA Mortgage Applications /7/2018 US Consumer Credit -- $20.078b 11/8/2018 GERMANY Exports SA MoM 0.30% -0.10% 11/8/2018 CHINA CPI YoY % 11/8/2018 US Initial Jobless Claims /8/2018 US Continuing Claims /8/2018 US Bloomberg Consumer Comfort /8/2018 US FOMC Rate Decision (Upper Bound) 2.25% 2.25% 11/8/2018 US FOMC Rate Decision (Lower Bound) 2.00% 2.00% 11/8/2018 US Interest Rate on Excess Reserves % 11/9/2018 UK GDP YoY 1.50% 1.20% 11/9/2018 US PPI Final Demand MoM 0.20% 0.20% 11/9/2018 US PPI Final Demand YoY 2.70% 2.60% 11/9/2018 US PPI Ex Food and Energy YoY 2.50% 2.50% 11/9/2018 US PPI Ex Food, Energy, Trade YoY % 11/9/2018 US U. of Mich. Sentiment /9/2018 US Wholesale Inventories MoM /9/2018 US Wholesale Trade Sales MoM % 11/9/2018 US U. of Mich. Expectations /11/2018 JAPAN PPI YoY % 11/12/2018 ITALY Industrial Production MoM % 11/13/2018 GERMANY ZEW Survey Expectations /13/2018 BRAZIL Retail Sales MoM % 11/13/2018 JAPAN GDP Annualized SA QoQ % 11/13/2018 US NFIB Small Business Optimism /13/2018 US Monthly Budget Statement -- $119.1b Source: Bloomberg, as of November 2, Wells Fargo Investment Institute. All rights reserved. Page 4 of 5

5 Risk Considerations 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. General Disclosures 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 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. 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. CAR Wells Fargo Investment Institute. All rights reserved. Page 5 of 5