​As Sam Sees It: What Could Push This Bull Market Dramatically Higher?

Sam Stovall |


Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.

EQ: The FOMC announced on Wednesday that it will begin to reduce its balance sheet by $10 billion per month starting in October, and that another rate hike in 2017 is in the cards. Is this pretty much in line with expectations?

Stovall: Yes and no. Expectations were for the FOMC to announce when it would start unwinding its balance sheet, however, most people on Wall Street were not expecting the Fed to raise rates again this year. Our feeling was that there was still a 50/50 chance for another rate increase in 2017 because inflation is likely to pick up as the year comes to an end. With that said, the Fed is still being the Fed, and is telling us that decisions on interest rates will be based on the underlying data. So, while the December rate hike is still on the table, it’s also certainly not a guarantee.

EQ: The balance sheet unwind marks a significant change in Fed policy for the first time in nine years. How significant of an impact do you see this having on the market and economy going forward?

Stovall: Well, the Fed is going from a QE (quantitative easing) to a QT (quantitative tightening) environment, and while tightening is never a good thing for the overall market, the Fed has a history of being very transparent and gradual. So, while we could see some softness in the near term, who has not been expecting the Fed to do this? They have been telling us they planned on doing this for quite some time.

EQ: Which sectors should investors be rotating toward in an environment in which the Fed is tightening more than it is stimulating?



Stovall: The real question is, will the QT have an upward effect on the 10-year Treasury note. Obviously, the Fed funds rate is being pushed higher, but we have not seen the 10-year note work its way higher dramatically, even though most on Wall Street thought that would the case even as far back as 2014. As a result, investors have been surprised by how low rates have gone.

Historically, whenever yields on the 10-year note have been rising, the sectors that have done best are those that are more cyclical in nature, with the top three being Information Technology, Energy, and Consumer Discretionary. You can also throw in Industrials and Materials. These have been the outperformers whenever the 10-year note has been rising.

The underperformers have been Health Care, Real Estate, Financials, Consumer Staples and Telecom. All have posted positive returns on average, but just less than the overall market. Only Utilities has been posted an average decline as many investors look upon them as bond surrogates.

EQ: As for the S&P 500, it eclipsed the 2,500 level this week, due in large part to the possibility that the Trump is back on the table. A new tax proposal is set to be unveiled next week. What kind of potential upside could this provide the market as the year winds down?

Stovall: It could provide a shot in the arm for the market, and serve as a catalyst to push the S&P 500 dramatically above the 2,500 level. By looking at both inflation and earnings estimates for the end of 2018, the Rule of 20 would imply that the S&P 500 trades at fair value of 2,511. If instead of a near-11% gain in earnings at a 2.1% rise in core CPI, earnings came in at a gain of 15% next year, then we’d be looking at about 2,890 on the S&P 500.

If earnings growth came in at 20% in the coming year, then the S&P 500 could be trading at about 3,010. So, everything all depends upon what this tax policy will have on corporate earnings. Capital IQ came out with a back-of-the-envelope estimate implying that for every percentage point reduction in the tax rate, it would equate to a one percentage point rise in earnings. So, should the tax rate drop from 35% down to 25%, then instead of 11% maybe we get 21% in earnings growth. That could definitely offer the catalyst that investors have been looking for to push this market dramatically higher.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Comments

Emerging Growth

Cavitation Techs Inc

Cavitation Technologies Inc engineers and designs Nano technology based systems that have potential applications in industrial liquid processing.

Private Markets

iPRO Network, LLC

We provide the platform, tools, and resources to empower individuals and professionals to market desirable goods and services to the public, taking the place of traditional methods of commerce.

Voleo

Voleo is a free download that allows you to form investment clubs with your friends, family, colleagues, classmates, teammates…basically anyone you know and trust. Invest and manage a stock portfolio…