Report highlights opportunities amidst volatility, favours intermediate fixed income
Investors and financial professionals are being warned to brace for a period of heightened market sensitivity following a sharp drop in the S&P 500 Index.
The Wells Fargo Investment Institute (WFII) says that the index experienced its largest six-month decline on October 10, falling 2.7% after the US and China intensified their trade rhetoric. China threatened export controls on essential rare earth metals, to which the US responded with the prospect of 100% tariffs on Chinese imports.
This escalation in trade tensions coincided with elevated Wall Street expectations for advancements in tech spending, tariff adjustments, and hiring, which had propelled a significant 31.50% rally between April 8 and October 10. While markets abroad and US equity futures recovered slightly over the weekend as both nations called for more talks, WFII anticipates that financial markets will "remain sensitive to news in the coming weeks".
The Institute’s perspective - detailed in the report from Doug Beath, global equity strategist, and Paul Christopher, CFA, head of global investment strategy - is that the US and China are likely "testing their leverage for coming negotiations," and the most significant takeaway is the "reflexive equity market reaction."
This sensitivity is expected to persist through the third-quarter earnings season, where investors will be closely monitoring earnings growth forecasts and forward guidance on tech spending and tariff adjustments. Any announcements regarding hiring or layoffs, while the government shutdown persists, could also influence currency, interest rate, and equity markets.
The Institute's analysis suggests that tariff price increases will be gradually and selectively passed through to retail consumers, but the pass-through will be more extensive at the business-to-business level. While they foresee a wider passthrough to consumer goods as businesses adapt to the levies, they expect only a limited overall impact on economic and earnings growth, as well as inflation.
WFII emphasizes that the current "heightened market sensitivity" could lead to sudden pullbacks, presenting opportunities for advisors and their clients.
It believes substantial cash is "on the sidelines" and that investors are "waiting for pullbacks to put liquidity to work". The Institute recommends utilizing market pullbacks to rebalance portfolios towards favored asset classes and sectors, aiming to mitigate near-term risk and uncover new prospects.
WFII favours US large- and mid- cap equities over small caps, emphasizing quality exposure across regions.
Sector preferences lean toward cyclical and AI-driven industries rather than defensive ones. Financials are expected to benefit from deregulation and a steepening yield curve, while Information Technology, Industrials, and Utilities should gain from AI-related investment. In contrast, Consumer Staples and Health Care are seen as likely laggards in a rising market, and Consumer Discretionary faces pressure from tariffs and weaker lower-income demand.
For fixed income, with anticipated Fed rate cuts reducing short-term yield potential and long-duration bonds carrying greater risk, WFII favours intermediate-term (3–7 year) investment-grade corporate and municipal securities. This positioning seeks to balance higher yields than short maturities with lower volatility than long-term bonds, capturing attractive income opportunities amid shifting rate dynamics.
