Q2 Market & Economic Update

Over the past year in Arizona, as well as the Tucson and Phoenix metropolitan areas, growth has risen broadly across most major metrics, notably population, wages and jobs. The 3 percent rate of job growth statewide has also outpaced the national average. Conversely, despite the favorable growth outlook over the next several years, the state is tied strongly to national trends and could be derailed by them if the economy starts to weaken in the interim. And even as the region has gained in job and income growth, overall incomes still trail the nation at large, and there is no sign that will change.

Economic Trends: In the short term, Brexit will Overshadow All Other Concerns

The June 23, 2016, United Kingdom (UK) referendum on European Union (EU) membership concluded with a market-surprising win for the “leave” vote. Global markets have shifted to a “risk-off” mode, with global stocks, the British pound and the euro all declining; while the U.S. dollar, gold and high-quality U.S. bonds are rallying. The market decline reflects the surprising nature of the vote, since many market watchers expected the vote to be in favor of “remain.” U.S. Bank Wealth Management sees the market reaction to be a response to the surprising outcome of the Brexit vote and the significant uncertainties it represents, rather than a negative statement concerning economic fundamentals or a sense that a major recession is now likely.

However, while the UK and Europe are important trading partners for the United States, it is believed the U.S. economy will continue to grow at a modest pace. The stronger U.S. dollar is a headwind to U.S. trade and exporters, but employment growth and wage gains should be sufficient to support the economy. Federal Reserve (Fed) policy may be less of a risk, since the Fed appears quite cautious in raising interest rates. Although a September rate hike is possible, the domestic economy, labor markets and inflation data would have to be firing on all cylinders in order for the Fed to feel comfortable normalizing rates in the face of global uncertainty. A December rate hike is the greater probability scenario, since the markets will need time to adjust to the potential longer-term impacts of a UK exit from the EU.

Equity market impacts

U.S. Bank Wealth Management believes equity market risks and volatility are likely to be elevated for the rest of the year, but fundamentals should remain supportive. However, the Brexit vote adds an additional element of uncertainty for performance related to equities in the second half of 2016 and perhaps beyond. The underlying premise has been, and continues to be, that an improving economy, both at home and abroad, is required to drive earnings, which are ultimately required to support higher stock prices. The decision for the UK to leave the EU is potentially an overhang to global growth and possibly to earnings of multinational companies. As such, potentially lower earnings and some price multiple compression implies overall muted returns.

While the risk profile of equities is elevated, the outlook for equities remains unchanged; the macro and fundamental backdrops remain supportive of equities, bolstered by no imminent signs of a recession or ramping up of inflation. A slow growing, low inflationary economy, with the Fed likely to keep interest rates lower for longer, typically elevates the attractiveness of companies paying and growing dividends at or above that of the S&P 500. Sectors such as Technology, Consumer Discretionary and Healthcare also appear attractive based on favorable relative valuations, attractive growth prospects and thematic appeal. In the view of U.S. Bank Wealth Management, the current 2016 price target for the S&P 500 is 2,100, within a range between 1,900 and 2,200.

Investment guidance

U.S. Bank Wealth Management believes in maintaining portfolio diversification. A slight tilt toward stocks (given the very low level of interest rates) may be warranted. Portfolio diversification can be important during market dislocations. A goal appropriate balance of global stocks, bonds, commodities and real estate is a key to weathering volatility, as we are now experiencing. U.S. equity markets generally offer a higher dividend yield than the yield offered on high-quality bonds, and the opportunity to participate in continuing economic growth indicates the possibility for solid value for stocks. It is the view of U.S. Bank Wealth Management that global central banks are likely to maintain lower interest rates for longer than had been expected, which can help reduce the risks of owning high-quality bonds. Returns are likely to be low, but the potential benefits of portfolio diversification are meaningful.

Jeffrey Kravetz is Regional Investment Director forThe Private Client Reserve of U.S. Bank in Phoenix.

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Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities.