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The New York Stock Exchange floor.
Michael Nagle / Bloomberg
A couple of Wall Street strategists have just come out with cautious outlooks on stocks this fall. They join a growing heart.
Experts in macro markets are as bullish as ever in the ongoing economic recovery, but much less in stocks. The reduction in the Federal Reserve, political drama and valuable valuations could fall on the stock market this fall.
Andrew Sheets, chief asset strategist at
Morgan Stanley,
sees a “crash” in the coming months and has consequently downgraded U.S. equities to the equivalent of Sell. And Savita Subramanian, head of US quantitative and equity strategy at BofA Securities, posted a pair of S&P 500 targets involving short-term losses and a better flat market by the end of next year.
“Investor sentiment and valuations are widening (there’s already a lot of optimism) and our long-term valuation model indicates negative returns for the S&P 500 over the next decade (-0.8% annualized returns) for the first time since Bubble technology, “she writes.
Subramanian expects the S&P 500 to fall to 4250 by the end of this year, with a 6% drop from current levels around 4500. He sees the index rise to 4600 by the end of 2022, which would be a gain barely 2% as of today.
Measuring Subramanian investor sentiment — an opposite indicator — shows euphoria, just as it begins to worry about profit margins and profit growth. He points to supply chain disruptions and inflation in wages and input costs as a result of headwinds toward profitability. In addition, interest rates are likely to be higher than lower over the next year (weighing the valuation multiples) and Subramanian does not like the level of the S&P 500 index very much.
Spreadsheets expects the Fed to announce plans to begin reducing monthly asset purchases later this month and for officials to also update its so-called “point chart” of future interest rate forecasts for show a faster-than-expected rate of uploads. These should increase Treasury yields, according to Sheets, by putting pressure on US stocks.
Congressional disputes over traditional and “social” infrastructure bills and possible higher corporate and personal taxes will produce some negative headlines in the coming weeks. And it is likely that economic growth and profit rates have already peaked for the current cycle, Sheets writes.
In the future, there are two ways to look at things: more fiscal stimulus, less Covid-19, and rapid, continued U.S. economic growth would encourage the Fed to tighten policy, boosting yields and declining stocks. Alternatively, slowing growth would be a challenge to expensive stocks and could lead to a “fear of growth” sale.
Either way, the implication is for negative stock market returns and Sheets prefers European and Japanese equities to the S&P 500. Morgan Stanley strategists have an S&P 500 target in mid-2022 of 4225, a decline of approximately 6% with respect to here.
“This is a normal dilemma,” Sheets writes. “After the initial rebound after the recession, growth is usually moderate. An improving economy tends to lead to more cost pressure and inflation as demand increases and labor markets tighten. It usually means that central banks change to tighten policy. “
This does not mean that there is an economic recession on the horizon or that profits will fall. It’s just a new phase of the cycle, in which the stock average doesn’t work so well.
Subramanian agrees: “This environment is bullish for U.S. interest rates, inflation, and economic growth-oriented companies,” he writes. “We see several areas of the market so well positioned despite our most cautious outlook on equities: buying inflation-protected returns and small US capitalizations.”
Small capitalizations tend to do well when economic growth is strong and Subramanian sees potential benefits from higher spending on government infrastructure and investment in corporate caps next year. In addition, cheaper relative valuations than uppercase capital letters make capitalization less elevated.
The Russell 2000 small-cap index is currently trading approximately 29 times its estimated earnings over the next twelve months, compared to an average of about 27.5 times in the last 25 years, according to Bloomberg data. This compares to the S&P 500 with more than 22 times today’s advanced profits and a long-term average of about 17 times.
Inflation-protected performance means dividend growth stocks. “Bonds offer performance without protection against inflation, commodities offer exposure to inflation but have no performance,” Subramanian writes. “Shares are in the middle: profits, unlike bond yields, are nominal and grow with inflation.”
In particular, Subramanian likes dividend growth stocks in sectors such as energy, finance and materials that will benefit from a growing economy and faster-than-average inflation.
These could include
bank of america
(ticker: BAC),
Citigroup
(C),
Newmont
(NO),
EOG resources
(EOG), or
Pioneering natural resources
(PXD), according to a De Barron screen dividend growth stocks in these industries.
Write to Nicholas Jasinski at [email protected]