Orlando's Outlook: FOMO? No, follow the growth

01-19-2018

Bottom Line For those investors who have regrettably found themselves on the wrong side of the S&P 500’s powerful 38% melt-up rally over the past 15 months, many have casually dismissed the market’s surge as FOMO—the fear of missing out. The painful reality, however, is that there are strong fundamental reasons for the equity market’s impressive ascent. With apologies to the shadowy Deep Throat character in “All the President’s Men,” investors need to follow the growth. 

Roar of the 'Animal Spirits'
Our research friends at the Well Fargo Economics Group have recently constructed a new quantitative Animal Spirits Index (ASI), which dates back to 1967 and uses a dynamic factor modeling approach, studying five key inputs. Their data-based conclusion is that animal spirits have soared over the past year or so, and have not been this robust since prior to the Great Recession. 

What sparked this sharp rebound? In our view, the shift to a more business- and market-friendly set of fiscal policy goals, including President Trump’s tax cuts, repatriation, the immediate expensing of capital spending on equipment and deregulation, among other objectives. That has helped to generate the lowest unemployment rate (4.1%) in 17 years, elevated consumer confidence, the best retail holiday shopping season in six years and solid manufacturing trends.

Corporate profit growth over the past year hasn’t been this strong in six years. Our research friends at Credit Suisse report that earnings per share (EPS) thus far in the fourth-quarter reporting season are up by 14% year-over-year, with nearly three-quarters of the companies beating consensus estimates by an average of 4.2%. Tech, health care, energy, industrials and materials are the strongest categories. Moreover, in two weeks’ time, we’re expecting that fourth-quarter GDP growth will be flashed at a gain of 3.2%, marking the third consecutive quarter that GDP growth has exceeded 3% for the first time in 13 years.

That improvement in economic and corporate profit growth prodded us to recently increase our S&P EPS estimate from $150 to $155 for 2018. Our price/earnings ratio target of 20 times earnings generates our full-year valuation objective of 3,100 by year-end, which is another 10% or so higher from current levels.

The only fly in the economic ointment at present is that despite the relatively weak dollar and record exports, November’s trade deficit expanded to its widest level in six years on a record surge in imports. True, inflation is starting to perk up (in part, due to the sharp 50% increase in crude oil prices over the past six months) and the yield curve is flattening, which raises questions about the Federal Reserve’s imminent leadership and policy transition from Janet Yellen to Jay Powell. In addition, we’ll be watching closely to see whether Congress can manage to keep the lights on in Washington past tonight’s budget deadline.

Upward adjustments to our GDP forecasts
The fixed-income and equity investment professionals who comprise Federated’s macroeconomic policy committee met this week to discuss fiscal and monetary policy in Washington: 

  • We enjoyed the best Christmas in six years, which should more than offset any drag from the wider trade deficit. So we are keeping our fourth quarter GDP estimate at 3.2% (versus 3.2% in the third quarter), while the Blue Chip consensus is unchanged at 2.7%, the Bloomberg consensus is at 3.0% and the Atlanta Fed’s GDPNow model is at 3.4%. The Commerce Department will flash this report next Friday (Jan. 26).
  • We are keeping our full-year 2017 GDP estimate unchanged at 2.3%, while the Blue Chip consensus is ticking its estimate up to 2.3%.
  • With tax reform completed, we are raising our GDP estimate for the first quarter of 2018 from 2.7% to 3.0%, while the Blue Chip consensus is raising its estimate from 2.3% to 2.5% (within a range of 1.9% to 3.2%).
  • Tax reform should be fully implemented by the second quarter of 2018, so we are raising our GDP estimate from 3.1% to 3.5%, while the Blue Chip consensus is raising its estimate from 2.4% to 2.8% (within a range of 2.3% to 3.4%).
  • We are raising our third quarter of 2018 GDP estimate from 2.7% to 3.1%, while the Blue Chip consensus also is raising its estimate from 2.3% to 2.6% (within a range of 2.1% to 3.1%).
  • We are also raising our fourth quarter of 2018 GDP estimate from 2.7% to 2.9%, while the Blue Chip consensus is raising its estimate from 2.2% to 2.5% (within a range of 2.1% to 3.0%).
  • So for the full-year 2018 GDP, we are raising our estimate from 3.0% to 3.2%, while the Blue Chip consensus has similarly increased its estimate from 2.5% to 2.7% (within a range of 2.4% to 3.0%).
  • We are initiating a full-year 2019 GDP estimate at 3.0%, while the Blue Chip consensus it initiating its estimate at 2.4% (within a range of 1.9% to 2.8%).

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