Why This Top Strategist Just Raised His S&P 500 Price Target -- ICYMI

Author:
Publish date:
Video Duration:
2:37

The recently hot U.S. stock market has prompted two strategists to turn slightly more bullish, with Stifel’s Head of Institutional Equity Strategy the most recent to turn more positive. 

Stifel’s Barry Bannister said the S&P 500 will reach 3,250 by the end of August, representing an 8% gain from current levels. Recently, Canaccord Genuity’s Chief Market Strategist, Tony Dwyer said his firm is willing to considering a more “offensive” approach in advising clients given the recent stock price performance of cyclical sectors, like banking, oil, consumer discretionary and industrials. 

"We now raise our S&P 500 price target to 3,250 by Aug-30, 2020 (in 3 months), supported by economic survey data improving/bottoming (consumer, services, industrial) and our expectation that the S&P 500 price-to-earnings expands (at prevailing low real bond yields) to offset weak earnings per share, typical of late-stage recession periods.” wrote Bannister in his note. 

Since May 13, the S&P 500 has risen about 7% and the spread between the 2-year and 10-year treasury yields has expanded, with the 10-year yield rising from 0.64% to 0.68%. State reopenings, muted increases in the spread of the virus, optimism on vaccine development and evidence that an ever-expanding money supply is supporting lending and spending have all contributed to the market’s run. In the last two weeks, the Invesco KBW bank ETF  (KBWB) - Get Report is up 25% and the S&P 500 Equal-Weight Consumer Discretionary Index is up 21%. The Vanguard S&P 500 Value ETF  (VOOV) - Get Report, which encapsulates many cyclical stocks, is up 9%. 

A key part of Bannister’s call is that the average earnings multiple on the S&P 500 should expand. Many have recently noted the stretched valuations seen on the index, which is trading at almost 24 times next year’s earnings. That’s high historically, as the average is usually around 16 or 17 times. But that’s with higher interest rates. Given the incredibly low interest rate environment, Bannister says this should correlate to a higher multiple. His price target reflects an almost 26 times multiple on consensus 2020 earnings per share estimates of $126 for the S&P. 

This isn’t mind boggling. Another way to think about this: investors will pay a higher price for stocks if interest rates offer a low opportunity cost of invested capital. 

So if investors are expecting the same risk premium on the return on equities as they normally do while rates fall, stock prices will rise. Historically, the equity risk premium, or the forward one-year earnings yield on the S&P 500 minus the 10-year treasury yield, sits at around 3.5%. Currently, the risk premium is at around 3.5%. Recently, it was closer to 4%, as stocks were a bit lower and investors wanted premium returns, given the risks. Those are a second wave of virus infections causing more lockdowns, which now seems far off, and more U.S. tariffs on Chinese goods. 

Bannister’s forecast implies an earnings yield of 3.8%, using consensus earnings estimates. The risk premium may be higher if yields rise slightly. 

Many, including Morgan Stanley’s Head of U.S. Equity Strategy Mike Wilson, expect treasury yields to be supported by inflation in 2020, as stimulus measures have boosted lending and supported spending of late. 

Also key to Bannister’s call is economic data in August. Most strategists note that the stock market usually prices in a recovery from a recession about 4 months before GDP growth moves back in the direction of positive, or when it inflects. Bannister sees the recent risk-on market as a signal that the current GDP contraction will lessen by August, indicating that it will soon turn positive. That would catalyze more stock gains, as it would signal to investors that relatively elevated stock prices have been valid. 

But aside from valuation metrics, Bannister sees a strong technical signal for his 8% upside call for the near-term. The index crossed both its 50-day and 200-day moving average in late May. Historically, that supports an 8% up move in three months, landing him at his price target. 

Watch More of the Latest Videos on TheStreet and Jim Cramer