WEEKLY GUIDANCE FROM OUR I NVESTMENT STRATEGY COMMITTEE. Scott Wren Senior Global Equity Strategist

Transcription

1 WEEKLY GUIDANCE FROM OUR I NVESTMENT STRATEGY COMMITTEE Scott Wren Senior Global Equity Strategist July 16, 2018 Making Sense of the Upcoming S&P Sector Changes» After the stock market closes on September 28, 2018, the S&P Dow Jones Indices (S&P) will make revisions to its Global Industry Classification Standard (GICS) structure.» The Telecommunications Services sector will be eliminated and replaced by the new Communications Services sector. A number of companies will be moved into this sector from the Information Technology and Consumer Discretionary sectors. What it may mean for investors» The GICS revision will make meaningful shifts in sector composition in three sectors. Our sector guidance could change as a result. As we noted in the June 20, 2018, equity section of this report, S&P will reconfigure its current 11-sector lineup after the stock market closes on September 28. These changes were announced last year in an effort to get the word out early so investors and asset managers would have time to acclimate to them. Some general information was released in recent months, and just last week S&P published additional details. The changes are actually occurring only in the Consumer Discretionary, Information Technology, and Telecommunications Services sectors. The remaining eight will be left untouched. Asset Group Overviews Equities... 4 Fixed Income... 5 Real Assets... 6 Alternative Investments... 7 As noted in our earlier publication, the Telecommunications Services sector will be eliminated and replaced by a new sector called Communication Services. This sector will contain a number of social media and entertainment software companies from the Information Technology sector. The new sector will also absorb companies in the advertising, broadcasting, cable and satellite TV, movie, and publishing industries from the Consumer Discretionary sector. Given these changes, the representation in terms of percentage of the S&P 500 Index s total market capitalization will fall by a noticeable amount for the Information Technology and Consumer Discretionary sectors. The new Communication Services sector, based on recent pricing, will make up a touch more than 10% of the S&P 500 s total market cap Wells Fargo Investment Institute. All rights reserved. Page 1 of 9

2 Making Sense of the Upcoming S&P Sector Changes This week, we thought it would be a good idea to highlight some of the specific stocks that will be changing sectors at the end of September. A number of these companies are what we would consider to be financial media darlings. Most get a lot of attention from investors as well. To sort out the most important changes, we have pulled the 35 largest-capitalization names in the S&P 500 from our FactSet database and, from those companies, listed the ones that will be moved to different sectors. Remember, the S&P 500 is a capitalization-weighted index. That means the higher the market capitalization of a company, the more influence its underlying stock price movements will have on the price of the index. That is likely the most important information for investors to get their arms around. Note that the 35 largest companies make up anywhere from just over 0.5% to just under 4% of the S&P 500 s total market capitalization. These are the companies whose price fluctuations typically drive their sectors index performance. In terms of each company s absolute capitalization, the range is just over $125 billion to slightly more than $900 billion. After the 35 largest companies, the relative capitalization values drop off rather quickly. Of these 35 companies, based on what we know right now, it appears that seven will be leaving the Information Technology, Telecommunication Services, or Consumer Discretionary sector and migrating to the new Communication Services sector. Of interest to many investors, three of the five FAANG stocks are involved. Those would be Facebook Inc. (FB), Netflix Inc. (NFLX), and Alphabet Inc. (Google) Class A (GOOGL) and Class C (GOOG) shares. The remaining FAANG issues, Amazon.com, Inc. (AMZN) and Apple Inc. (APPL), will remain in their current spots in the Consumer Discretionary and Information Technology sectors, respectively. What about the other mega-cap names in this top-35 list that will be moving to the new Communication Services sector? As the graphic below shows, Comcast Corp. (CMCSA) and Walt Disney Co. (DIS) will be moving to Communication Services from the Consumer Discretionary sector. In addition, telecom behemoths AT&T Inc. (T) and Verizon Communications Inc. (VZ) will be moved into this newly formed sector as the Telecommunications Services sector is phased out. Information Technology (Current) Alphabet Inc. Class A (GOOGL) Alphabet Inc. Class C (GOOG) Facebook Inc. (FB) Communication Services New sector (as of market close on September 28, 2018) Consumer Discretionary (Current) Comcast Corp. (CMCSA) Netflix Inc. (NFLX) Walt Disney Co. (DIS) Telecom Services (Current) AT&T Inc. (T) Verizon Communications Inc. (VZ) Sector will be eliminated as of market close on September 28, 2018 Sources: S&P Dow Jones Indices, FactSet, Wells Fargo Investment Institute Wells Fargo Investment Institute. All rights reserved. Page 2 of 9

3 Making Sense of the Upcoming S&P Sector Changes In coming weeks and months, the Equity Strategy group will be working to determine how the new sector configuration may affect our sector guidance recommendations. Currently, the Consumer Discretionary sector is rated favorable, the Telecommunications Services sector is rated unfavorable, and the Information Technology sector is rated neutral within our five-tier guidance system. Obviously, we will be dropping the guidance on Telecommunications Services and will be initiating guidance on the new Communication Services sector. We will continue to update investors as new information becomes available from S&P in the coming weeks Wells Fargo Investment Institute. All rights reserved. Page 3 of 9

4 EQUITIES Sameer Samana, CFA Global Equity and Technical Strategist Don t be tempted by defensive sector outperformance U.S. Small Cap Equities U.S. Large Cap Equities U.S. Mid Cap Equities Developed Market Ex-U.S. Equities Defensive sectors that are less prone to swings in economic activity, such as Consumer Staples and Health Care, and interest-rate-sensitive sectors, such as Utilities and Real Estate, had a tough start to the year. Much of this underperformance was due to investors expectations for faster economic growth and higher interest rates, which led them to favor more cyclical sectors. However, the market pullback in February and concerns about tighter monetary policy, rising interest rates, and heightened trade tensions have created doubt in investors minds about the economic trajectory going forward. This can be seen in the sector performance over the past month, as Utilities, Real Estate, Consumer Staples, and Health Care have led the way while previous stalwarts, such as Industrials, Financials, and Technology, have underperformed. We believe this creates a selective opportunity for investors to rotate sectors in their portfolios, as our constructive outlook for financial markets leads us to favor some of the cyclical sectors that have underperformed, such as Industrials and Financials, while shying away from recent outperformers, like Utilities and Consumer Staples.» Defensive and interest-rate-sensitive sectors have led the way recently as investors have focused more on downside risks.» We believe this creates an opportunity for investors to rotate out of these areas and into cyclical sectors that have been recent underperformers, such as Industrials and Financials. Recent S&P 500 sector performance 8.00% 6.00% Emerging Market Equities Return (YTD) 4.00% 2.00% 0.00% -2.00% -4.00% -6.00% Source: Bloomberg, Wells Fargo Investment Institute. Daily data from June 9, 2018, to July 9, YTD = year-to-date. Sector returns are based on the S&P index for the respective GICS sector. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results Wells Fargo Investment Institute. All rights reserved. Page 4 of 9

5 FIXED INCOME Brian Rehling, CFA Co-Head of Global Fixed Income Strategy Why own bonds? Unfavorable U.S. Taxable Investment Grade Fixed Income U.S. Short-Term Taxable Fixed Income U.S. Intermediate Term Taxable Fixed Income Most Unfavorable U.S. Long-Term Taxable Fixed Income Unfavorable High Yield Taxable Fixed Income Unfavorable Developed Market Ex.-U.S. Fixed Income Emerging Market Fixed Income Our expectation is that high-quality fixed-income investments will offer investors positive low-single-digit returns in the years ahead. If you are asking yourself why you should own fixed income when our expectation is that it will produce lower returns than equities, we urge you to consider the bigger picture. Diversification. The future is often uncertain. While we may have a strong feeling of what tomorrow will bring, unforeseeable events often alter reality. Taking too large a bet on any one particular outcome increases your risk significantly. Investment strategies based on concentrated allocations are usually higher-risk.* Reduced volatility. In our opinion, one of the primary reasons to continue to own fixed-income investments, even if interest rates increase, is the lower volatility these investments typically offer when compared to stocks. Bonds, when used properly as part of a diversified investment strategy, may help smooth out your portfolio s overall performance over the long term. Liquidity. Most bonds have a maturity date at which principal is returned to investors if the issuer has not defaulted. If you are able to anticipate future cash needs, purchasing high-quality credit instruments with maturities near those occasions can be an effective way to remain invested in the markets while maintaining some assurance that funds will be available when you need them. Income. Income and cash flow are important needs for most investors. If you hold a bond to maturity, and the issuer does not default, you will receive your expected cash flow, regardless of whether interest rates increase or decrease. However, it is important to remember that if you have locked in a yield for a long period of time and the prices of goods and services you buy begin to increase rapidly, you may not be able to generate enough cash flow to meet your spending needs. With most individual bonds, your cash flow is generally fixed until the bond you hold matures.» We believe investors should ensure their bond portfolio is well diversified across maturities and credits. Tactically, we remain underweight duration (a measure used to determine a bond s sensitivity to movements in interest rates).» While we look for rates to modestly rise from current levels, we believe investors should continue to own recommended bond allocations.» For a more in-depth discussion on the benefits of bonds, please ask your investment professional for the full Why Own Bonds report. *Diversification does not guarantee investment returns or eliminate risk of loss Wells Fargo Investment Institute. All rights reserved. Page 5 of 9

6 REAL ASSETS John LaForge Head of Real Asset Strategy Anything that can be put in a nutshell, should remain there. --Bertrand Russell Oil tariff talk finally hitting it Unfavorable Commodities Private Real Estate Public Real Estate Over the last month, overall commodity performance has been horrific. In our view, much of this can be blamed on the amped-up rhetoric around global tariff wars. In the past month alone, the key commodities of soybeans, copper, corn, aluminum, and wheat are down -14%, -13%, -12%, -10%, and -9%, respectively. One key commodity, oil, had largely avoided sinking with the tariff drama until last week that is. Prices finally capitulated last Wednesday the day President Trump announced tariffs on an extra $200 billion of Chinese goods. West Texas Intermediate (WTI) and Brent prices declined -5% and -6%, respectively. Is oil finally getting dragged into the tariff talk mud? Yes, we believe it likely is. Oil is, after all, the largest traded global commodity (in U.S. dollar terms). We continue to see lower oil prices in the back half of Our main driver behind this guidance is oversupply, but amped-up tariff talk will likely contribute, too. At risk, should more tariffs against the U.S. come to pass, are U.S. oil producers. This may sound like an obvious statement today, but prior to 2015, it was not. The reason is that the U.S. government largely banned oil exports, except for trade with Canada (see the blue area in the chart below), prior to Since 2015, the U.S. has exported crude oil to 46 different countries. As of March 2018, the biggest single buyer of U.S. crude oil was drumroll please China. Hmm.» Tariff talk hit oil prices last week.» We expect lower oil prices by year-end. U.S. crude oil exports by country (3-month average) Thousand barrels per day Canada China Italy South Korea U.K. Other Sources: Energy Information Administration (EIA), Wells Fargo Investment Institute. Monthly data: January 31, 2013-April 30, Wells Fargo Investment Institute. All rights reserved. Page 6 of 9

7 ALTERNATIVE INVESTMENTS Justin Lenarcic Global Alternative Investment Strategist Private Equity Hedge Funds-Macro Hedge Funds-Event Driven Hedge Funds-Relative Value Most Hedge Funds-Equity Hedge The fourth asset class has been the second best performer Behind equities, the second best performing asset class over the last two years has been hedge funds. In fact, even though hedge fund performance was slightly negative in June (the HFRI Fund Weighted Composite Index was down -0.46%), it was only the fourth month in the last 24 when hedge funds failed to generate a positive return. On the other hand, global fixed income (represented by the Bloomberg Barclays Global Aggregate Bond Index) has generated negative returns in 11 of the last 24 months. Since July 2016, the total return of global fixed income is -0.9% compared to over 14% for hedge funds. We think this is a dynamic worth underscoring as it brings to light the fact that the fourth asset class has been a more important driver of returns than at any point in the post-crisis period. Referencing a two-year time frame is intentional as we believe that the second quarter of 2016 marked an inflection point for active management, driven in part by correlations dropping in response to changes in monetary policy and global interest rates. For qualified investors, the chart below highlights the potential effect of replacing a 40% global bond allocation within a 60/40 portfolio with a 40% allocation to hedge funds. This is not a recommendation as we still believe that diversification across all asset classes is critical for long-term investing success. But it does indicate how hedge funds have largely benefited from the very same conditions that have challenged fixedincome portfolios over the last two years.» Alternative investments have been the second best performing asset class over the last two years with hedge fund returns being higher and more consistent than global fixed income.» Conditions for the relative outperformance of hedge funds remain in place, especially with expectations of higher interest rates. Hypothetical 60/40 portfolio Alternative investments, such as hedge funds, private equity, private debt, and private real estate funds are not suitable for all investors and are only open to accredited or qualified investors within the meaning of U.S. securities laws. Index value % Global equities / 40% Global bonds 60% Global equities / 40% Hedge funds Source: Bloomberg, July Data shown from July June Global equities are represented by MSCI World Total Return Index; global bonds by Bloomberg Barclays Global Aggregate Bond Index and Hedge funds by HFRI Fund Weighted Composite Index. Please see next page for important information on hypothetical portfolios Wells Fargo Investment Institute. All rights reserved. Page 7 of 9

8 Performance results for the 60/40 Portfolio are hypothetical and for illustrative purposes only. Hypothetical returns do not represent investment returns or the results of actual trading. Index returns represent general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. Unlike most asset class indices, HFR Index returns reflect deduction for fees and expenses. Because the HFR indices are calculated based on information that is voluntarily provided actual returns may be higher or lower than those reported. An index is unmanaged and not available for direct investment. Hypothetical and past performance does not guarantee future results. Both stocks and bonds involve risk and their returns and risk levels can vary depending on prevailing market and economic conditions. Bond prices fluctuate inversely to changes in interest rates. Foreign investing has additional risks including currency, transaction, volatility and political and regulatory uncertainty. These risks are heightened in emerging markets. Hedge funds are complex, speculative investment vehicles that are highly illiquid, and involve substantial risk. They are intended for qualified, financially sophisticated investors who can bear the risks associated with them. Hedge funds use strategies that differ from long-only equity investing. They may expose investors to the risks associated with short selling, leverage, the use of derivatives and other investment practices that are speculative and involve a high degree of risk. Please see below for additional risks associated with these asset classes and for the definitions of the indices. Risks 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. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. 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. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions. Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is suitable only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing. 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. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players; reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. 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 a investment to adverse economic or regulatory occurrences affecting the sector. Some of the risks associated with investment in the Health Care sector include competition on branded products, sales erosion due to cheaper alternatives, research and development risk, government regulations and government approval of products anticipated to enter the market. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio's performance. Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues. Real estate investments have special risks, including possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions. 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 smaller, less-seasoned companies, tend to be more volatile than the overall market. The telecommunications sector is subject to the risks associated with rising interest rates which could increase debt service costs, competition, increased costs to providers due to potential 2018 Wells Fargo Investment Institute. All rights reserved. Page 8 of 9

9 for large equipment upgrades. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy. Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund. Definitions An index is unmanaged and not available for direct investment. Bloomberg Barclays Global Aggregate Bond Index provides a broad-based measure of the global investment grade fixed-rate debt markets. It is comprised of the U.S. Aggregate, Pan-European Aggregate, and the Asian-Pacific Aggregate Indexes. It also includes a wide range of standard and customized subindices by liquidity constraint, sector, quality and maturity. HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 2,000 single-manager funds that report to HFR Database. Constituent funds report monthly net-of-all-fees performance in U.S. dollars and have a minimum of $50 million under management or a 12- month track record of active performance. The HFRI Fund Weighted Composite Index does not include Funds of Hedge Funds. MSCI World Index is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets S&P 500 Index is a capitalization-weighted index calculated on a total-return basis with dividends reinvested. The index includes 500 widely held U.S. market industrial, utility, transportation and financial companies. 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 9 of 9