The next move up could be more revaluation than earnings story
As we close out a decent September, we remain bullish on stocks, are sticking with our 3,100 year-end target on the S&P 500 and continue to recommend investors stay overweight equities in balanced portfolios. We see three main positive drivers ahead, the last one being key:
- Trade wars are not getting worse and could get a little better, the Fed and other central banks are not tightening and may ease more, and fiscal easing is coming—it’s already happening in China, which has been slowing the most, and is almost certain to come to Germany, where its manufacturing economy is in recession and its fiscal condition would easily allow for more spending. As for the U.S., it’s an election year—for both parties.
- “Made in the USA” is now a label that matters. The lesson for many companies from the China trade war is that it’s safer long-term to source product in the country where it is sold. This is good for investment flows into the U.S. The recent missile attack on the Saudi oil facilities has created a similar lesson for oil-importing countries—oil supply lines are safer if they are coming from the U.S. instead of the Mideast. We expect an acceleration of investment in the U.S. oil patch over the next two to three years as a result. All of this is good for the domestic manufacturing sector.
- Most important, investors are almost certain to revalue stocks higher, not because of earnings but because of falling yields. We think the really interesting Fed “dot” from last week was the expected long-term rate. It’s dropped from 3% to 2.5% in the last year, even as earnings have grown about 8%. Most investors I talk to now think the likely longer-term settling point for the 10-year Treasury yield has downshifted from 3-4% a year ago to 2-3% today. Yet equities over the last year are almost flat, up just 3%. So even as the expected long-term discount rate on stocks went down, valuations went down, too, not up as they should have. As recession fears recede, we expect this situation to normalize, with equity valuations moving higher even as earnings initially don’t. I can assure you this would be a very frustrating moment for the bears, who will be complaining “fundamentals are not getting better yet stocks are going up! This is crazy!” You heard it here first.
Sectors we like
In this anticipated environment, virtually all sectors benefit. The dividend stocks gain a lot from the revaluation story and should do well. In addition, the cyclical sectors including financials, small-caps and industrials should benefit both because they are deeply under-owned and as the global economy stabilizes, investors will begin to look at them for the next re-acceleration. Energy and especially U.S. shale-oriented stocks also stand to gain as global attention turns to our domestic producers.