The meltup in stocks has surprised many market players, but one top strategist says this could be just the beginning.
The S&P 500 could touch 3,800 this year, Stifel’s head of institutional equity strategy, Barry Bannister, wrote in a note. Bannister expects a significantly rising money supply in the U.S. to cause earnings multiples to expand rapidly.
Bannister has raised his price target on the S&P 500 to 3,450 from 3,260, as he sees the lower interest rates the Federal Reserve induced in 2019 to continue to flow through the economy.
Fed Chairman Jerome Powell mentioned in a recent Fed meeting that monetary policy often operates with a lag, as business and consumers don’t immediately increase or reduce spending when rates change. Bannister’s new index target indicates 2.25% upside from the market’s current level.
He held back his base case from 3,800 because he factors in the risk of a recession in 2020. “The risk to our thesis is a global recession in 2020, led by overseas weakness if the [coronavirus] spreads,” he said.
Should the coronavirus spread faster than many think it will, it could prompt Chinese manufacturing plants to shut long enough to cause the U.S. to import far fewer goods than expected. That would translate to lower sales and potentially a recession. (The spread of the virus is slowing, and many expect it to soon be eradicated.)
Bannister’s bull case of 3,800 represents 12.5% upside from the index’s current level. Some observers reject this prospect since forward-earnings multiples on the index are averaging 19, well ahead of the 10-year average of 15. And many analysts see the economy as late in its cycle.
But let’s explore this bull case.
It starts with the expectation that the global money supply, in U.S. dollars, rises 7% to 9% in 2020 from the year earlier. This is consistent with the monetary easing seen from central banks worldwide and with the prospect that the U.S. lowers interest rates further in the year.
As for the roughly 8% increase in global supply, Stifel uses the Goldman Sachs Financial Conditions Index, which measures how loose or tight global financial conditions are and therefore the direction of economic growth.
The index appears set to rise roughly 0.75% in 2020, which should equate to that increase in money supply, Bannister says. He notes that the added liquidity is driven largely by excess reserves held by the Fed, which typically works to improve global money supply.
Historically, such an increase in global liquidity correlates with a 17% annual gain for the S&P 500. The index’s closing price on the last day of trading in 2019 was 3,230, 17.5% below the 3,800 level.
Importantly, strategists use many factors to predict the direction of markets. Monetary policy and interest rates are one of the most important factors, but investors should also keep track of other factors that play a role, including political and fiscal-policy changes.
Bannister notes — unsurprisingly — that most of his bull-case gain would come through expanded multiples, not higher one-year earnings expectations. His bull-case target represents a forward-earnings multiple on consensus S&P 500 2020 earnings estimates of 21. It would be 23 times Stifel’s earnings-per-share estimate of $165 for the members of the S&P 500. More liquidity and low interests stimulate spending and can provide a boost to revenues, but low rates also lower the discount rate at which profits are discounted, boosting valuations.
Wall Street sees the earnings number for 2020 coming in at $178. That $178 earnings number represents roughly 9% growth over 2019. And since 2021 EPS-growth estimates are roughly in line with those of 2020, U.S. stocks can't rise this much if earnings multiples are to stay range-bound.
Bannister likes cyclical stocks over defensive stocks, touting industrials, materials, energy and financials as sectors investors should be looking at. Those sectors have underperformed the S&P 500’s 4.5% year-to-date gain.
Bank stocks have been pressured as the yield curve has moved closer to inversion again. The market rally has been largely a safe one, with defensive stocks and government-bond prices shining.
The 10-year and 3-month treasury yields are now at 1.63% and 1.55%, respectively. Bannister expects the yield curve to ultimately expand by the end of 2020, benefitting financials. Citigroup C and Bank of America BAC, for example, are both down 2% so far this year.
Stifel may have its bull case, but other strategists warn for both the short and long term.
Canaccord Genuity Chief Equities Strategist Tony Dwyer is looking for a near-term pullback due to higher multiples. UBS Global Wealth Management notes that 2019’s debt-to-GDP level was higher than it was just before the financial crisis, as low interest rates provided incentive to borrow.