Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Stocks have essentially gone straight up since the start of the year, driven primarily by the Trump tax cuts passed at the end of 2017. Has this created a full risk-on market environment right now?
Stovall: Well, it seems as if investors are adopting a FOMO (fear of missing out) mindset. We continue to hear strategists in the financial press talk about a potential melt-up in stock prices. My concern is that right now, Wall Street analysts are expecting about $146 per share in earnings for the S&P 500 for all of 2018. We at CFRA are forecasting $155, and even with the elevated forecast on our part, the market is essentially closing in on our year-end 2018 S&P 500 target of 2,800 within the first month of the new year.
So, yes, I am concerned that investor sentiment is getting a bit frothy.
EQ: This might be a little premature, but will CFRA adjust its year-end target as a result of this early jump?
Stovall: We will have to evaluate how fourth quarter earnings are coming in, combined with the guidance that we are likely to get for coming quarters before we make any kind of decision, up or down.
EQ: Speaking of earnings, in this week’s Sector Watch report, you said fourth quarter results are largely a formality at this point, but guidance for 2018 should have meaningful implications for analyst expectations, and therefore, investors’ outlook. Considering the amount of optimism in the market right now, what are analysts and investors looking to hear from corporate management?
Stovall: I would tend to think that we would have to get guidance that’s even better than the 20% increase in earnings that we have factored into our full 2018 earnings estimates. I use something called the Rule of 20, which looks at earnings, combined with inflationary expectations. To me, it implies that fair value for the S&P 500 is closer to 2,800, but we’ve been hearing strategists talking on TV leapfrogging one another with estimates of 3,000, 3,100 or even higher.
EQ: The top performers for Q4 earnings season are expected to be Energy, Materials, and Information Technology sectors. Energy in particular continues to show astronomical EPS growth rates during its recovery. Are those rates off low comps due to normalize soon?
Stovall: They are definitely coming off of low comps, to the point where we had a 90% decline in earnings for the Energy sector in 2015 and into 2016. In 2017, we had a more than 250% increase in earnings. For 2018, the expectation is for a number below 50%. So yes, the further we get from the bottom, the more normalized the earning growth expectations will become.
EQ: One group that isn’t among the expected top performers necessarily, but has received a lot of optimism towards it since the Trump Presidency started is the Financials sector. Earnings have been somewhat bumpy for 2017, but 2018 EPS growth is expected to reach nearly 20%. What are some tailwinds propelling this group?
Stovall: Initially, I believe there was optimism toward the likely reduction in regulatory pressures that were placed on the sector after the Financial Crisis and with the prior administration. The expectation was that a lot of those pressures would be relieved. Now, we’re also realizing that since the Fed, even though they are raising short-term rates, are going to be engaging in quantitative tightening—unwinding their balance sheet—which we believe will allow the yield on the 10-year note to rise as well. Our expectation is that we could end up seeing the yield curve steepen a bit, which would actually be beneficial to the Financial stocks since they make money from that spread.
So, as a result, I think investors are essentially saying yes, there could be fewer regulations, but also at the same time, the actions of the Fed will actually end up benefiting the bottom line of these banks.
EQ: With so much bullish sentiment, it’s easy to overlook the fact that not every sector is expected to thrive in this market environment. What are some of the groups that are proving to be the laggards here?
Stovall: In terms of earnings growth laggards, at least for the fourth quarter, are expected to be Health Care, Industrials, Utilities, and Telecom, which are showing relatively weak-to-anemic growth. Real Estate is actually expected to show a near 12% decline in the fourth quarter.
The real question is what’s likely to happen for 2018, and we do think we’re going to be seeing a ramping up of earnings growth for the Industrials sector by the fourth quarter of next year. So, it seems to be sort of a good upward trajectory for cyclical sectors, whereas we still believe that the Telecom Services, Consumer Staples and Utilities groups are likely to be laggards.