Two Wall Street strategists just posted a cautious outlook for equities this fall. They join a growing choir.
Macro market experts are more bullish than ever on the ongoing economic recovery, but far less on equities. The crumbling Federal Reserve, political drama and high valuations could all stumble the stock market this fall.
Andrew Sheets, Chief Cross-Asset Strategist at
sees a “bumpy” period over the next few months and, as a result, has downgraded the rating of US stocks to the equivalent of Sell. And Savita Subramanian, head of US equities and quantitative strategy at BofA Securities, released a pair of S&P 500 targets that imply short-term losses and a flat market at best until the end of next year.
“Investor sentiment and valuations are broad – a lot of optimism is already built in – and our long-term valuation model shows negative returns for the S&P 500 over the next decade (-0.8% returns annualized) for the first time since the tech bubble. ,” she writes.
Subramanian expects the S&P 500 to fall to 4,250 by the end of this year, down about 6% from current levels around 4,500. She sees the index rebound to 4,600 by the end of this year. 2022, which would represent a gain of barely 2% compared to today. .
Read more: Barron Fall Market Outlook
Subramanian’s measure of investor sentiment – a contrarian indicator – signals euphoria, just as she begins to worry about profit margins and earnings growth. It highlights supply chain disruptions and inflation in wages and input costs as barriers to profitability. Add to that: interest rates will likely be higher than lower over the coming year, weighing on valuation multiples, and Subramanian won’t like much about the S&P 500 index. .
Sheets expects the Fed to announce its intention to start cutting monthly asset purchases later this month, and officials also update their so-called “dot plot” of rate forecasts. future interest to show a faster rate of increase than expected. These should push up Treasury yields, Sheets argues, putting pressure on US stocks.
Congressional wrangling over traditional and “social” infrastructure bills – and higher corporate and personal taxes – will make headlines in the weeks to come. And rates of economic growth and earnings have likely already peaked for the current cycle, writes Sheets.
Going forward, he sees it two ways: more fiscal stimulus, fewer Covid-19s, and continued rapid economic growth in the United States would encourage the Fed to tighten policy, pushing up yields and lowering. stocks. Alternatively, slowing growth would present a challenge for expensive stocks and could cause a “growth fear” sell-off.
Either way, the implication is for negative stock returns, and Sheets prefers European and Japanese stocks over the S&P 500. Morgan Stanley strategists have a mid-2022 S&P 500 target of 4225, down from about 6% compared to here.
“It’s a normal dilemma,” Sheets writes. “After the initial post-recession rebound, growth generally moderates. An improving economy typically leads to more cost pressure and inflation as demand increases and labor markets tighten. This usually means that central banks are reorienting themselves to tighten their policy. “
This does not mean that an economic recession is on the horizon or that profits will decline. It’s just a new phase in the cycle, and one where the average stock isn’t performing as well.
Subramanian agrees, “This is a bullish environment for interest rates, inflation, and companies focused on US economic growth,” she writes. “We believe that several areas of the market are well positioned despite our more cautious outlook on equities: buying inflation-protected yields and US small caps.”
Small caps tend to do well when economic growth is strong, and Subramanian sees the potential benefits of increased government infrastructure spending and corporate capital investment in the coming year. In addition, relative valuations cheaper than large caps make small caps less attractive.
The Russell 2000 Small Cap Index is currently trading at about 29 times its estimated earnings over the next 12 months, compared to its average of about 27.5 times over the past 25 years, according to Bloomberg data. This compares to the S&P 500 at over 22 times the forward earnings today and a long term average of around 17 times.
An inflation protected yield means dividend growth stocks. “Bonds offer a return without protection against inflation, commodities offer exposure to inflation but no return,” writes Subramanian. “Equities sit in the middle: earnings, unlike bond yields, are nominal and rise with inflation. “
In particular, Subramanian likes stocks with increasing dividends in sectors like energy, financials and materials which are expected to benefit from a growing economy and faster than average inflation.
These could include
Bank of America
Pioneer of natural resources
(PXD), according to a Barron filter stocks for dividend growth in these industries.
Write to Nicholas Jasinski at [email protected]