Aside from the macroeconomic outlook, which points to higher growth, and the Trump administration’s well-known intentions for fiscal spending, tax cuts, and lower regulation, the stock market itself has some catching up to do, says RBC Wealth Management’s Alan Robinson.
“It’s been a below-par bull market and it’s also against the backdrop of a bear market that we’ve effectively had since 1999,” Robinson said. “So there’s a lot of catch-up to be done there and the slow pace of the advance argues for continued bullishness at least through the end of this year.”
RBC is one of the most bullish on the stock market with a 2,500 year-end target for the S&P 500. That represents a gain of 11.7 percent from the 2016 close of 2,239.
The catch-up theme also applies to earnings. S&P 500 aggregate earnings haven’t changed much since 2015, but RBC estimates they’ll grow 8 to 9 percent in 2017. Goldman Sachs forecasts the stabilization in energy sector earnings to be the primary driver behind a 10 percent rise in S&P 500 earnings in 2017. Aside from energy, Goldman estimates S&P 500 earnings to rise by 6 percent led by financials and information technology.
Earnings are expected to increase as are what investors are willing to pay for them—price-to-earnings multiples, which RBC sees increasing from 17.5 to 17.9.
Robinson says the reasons for optimism are twofold: Low interest rates, which impacted the earnings of the financials, and excessive oil supply, which hurt the energy and other cyclical sectors, are becoming less of an issue.
And with greater economic growth comes higher revenues for companies. The Trump rally is one thing, but Robinson says, “The underlying driver for longer-term investors is this idea that the economy is fixing to repair itself regardless.”
Financials would be the biggest beneficiaries of less regulation, not to mention higher interest rates and a steepening yield curve (long-term interest rates rising faster than short-term ones).
Tide Doesn’t Lift All Boats
Many see 2017 as a stock-picker’s year. BlackRock’s Chief Equity Strategist Kate Moore says the low volatility environment is an illusion and suggests a tactical approach rather than a broad market approach.
Goldman notes that the dispersion in sector returns has started to climb, after staying low since mid-2016, and that the correlation of returns between sectors has dropped dramatically since the election. In other words, the tide of optimism is not lifting all boats equally.
Goldman recommends that investors reduce exposure to “bond proxy” sectors like consumer staples, telecoms, utilities, and real estate as bond yields and the federal funds rate rise through 2017.
RBC recommends cyclical and low price-to-earnings stocks.Sector rotation worked well in 2016, but Robinson says a more “directional type of trade” should be more profitable in 2017. Sector-wise, the financials, health-care, energy, materials, and industrials are expected to outperform.
But for the time being RBC isn’t putting new money to work. “Sentiment is a little too bullish, so we do think that we’ll have some kind of pullback this month,” Robinson said.
“We would perhaps put some new money to work on a pullback,” he said. “We just think that the reflation trade, the ‘Trumpanomics’ trade is just too well telegraphed in the market right now.”
The other catch-up aspect facing stocks is in mutual fund flows. Since the election, roughly $3 trillion has moved from bonds into stocks globally, according to Deutsche Bank research. Robinson says that in the last three years, flows into equity mutual funds have lagged those going into bond funds.
“I get the sense that frankly, there’s still a fair amount of powder left,” Robinson said.
Goldman expects the S&P 500 to rise to 2,400 in the first half of 2017, but to then fall to 2,300 by year-end as interest rates rise further, causing investors to change their outlooks.
“We still caution that equities are vulnerable should rates move too much, too fast, given stretched [stock market] valuations following years of exceptionally low rates,” noted Goldman in its 2017 outlook.
Robinson is more cautious as 2018 approaches due to the potential for Trump’s policies to stoke inflation. “Trump’s policies have the effect of putting the foot on the gas just as we’re cresting the hill,” Robinson said. “And that could have some implications further down the line.”
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