Equity markets will likely be “choppy and volatile” within a broader range in the coming months, according to Wells Fargo.
The equity market has seen a strong rebound since the lows on August 5, with investors quickly regaining confidence after the July employment report, which had initially caused concern due to falling far below consensus expectations.
Although the report sparked fears of a sharp economic slowdown and speculation that the Federal Reserve (Fed) was behind the curve on rate cuts, the data wasn't as dire as it seemed. Some financial commentators even called for an immediate emergency rate cut of 75 basis points.
However, Wells Fargo strategists believe "there was no need for an emergency cut and that those fears were overblown."
They said recent data has supported this view, indicating that while the economy is slowing, the likelihood of a recession remains low. Moreover, consensus earnings estimates for the remainder of 2024 and 2025 have edged higher over the past three months, according to Bloomberg data. This improved outlook has brightened market sentiment, with both stocks and bonds rallying.
Still, Wells Fargo cautions investors against getting overly optimistic, as the S&P 500 Index (SPX) has rallied to just 1.5% below its mid-July all-time high. While the index shows potential upside toward their 6,000 target for year-end 2025, it is currently trading above their 5,400 target for the end of this year.
"In other words, we think the market may be getting ahead of itself, especially if we trade very near the record SPX high (5,667),” strategists wrote.
Another factor to consider is the historical performance of the market in September, which, according to the Stock Trader’s Almanac, has the worst average performance for the SPX since 1950. Although Wells Fargo doesn't recommend making portfolio decisions solely based on seasonal trends, they do expect some market choppiness and volatility in the upcoming months.
Should the S&P 500 approach its record high, Wells Fargo suggests trimming exposure to emerging-market equities, as well as sectors like Consumer Discretionary, Consumer Staples, Real Estate, and Utilities, which they rate lower.
"We suggest these funds be reallocated to our highest-rated large-cap sectors including Energy, Communication Services, Financials, Materials, and Industrials."
Strategists also recommend bringing small-cap domestic equities up to a neutral position in portfolios and view pullbacks toward recent lows as buying opportunities in their favored sectors.