Barclays' Barry Knapp has joined the growing crowd of 'sub-1400 year-end S&P 500 target' realists among sell-side equity strategists. With Morgan Stanley's Adam Parker at 1167 and Goldman's David Kostin at 1250, Knapp just reduced his target to 1325 as he notes "the election scenario that unfolded was the one with the most risk, the status quo outcome." In a brief but densely packed interview on Bloomberg TV (the likes of which we suspect we will not see on CNBC), Knapp summarizes his non-rose-colored-glasses view: "In the longer term, while U.S. growth ... remains constrained by policy uncertainty and balance sheet deleveraging. Financial repression has limited the Fed’s effectiveness... We believe a period of significant equity market valuation improvement can’t begin until the Fed initiates the exit strategy process, which is unlikely to occur until Federal government debt sustainability is addressed." From lame-duck impotence to tax-selling pressures, Knapp nails our new reality and explains, as we have been saying, that the only solution lies in a market-forced move: "We suspect, absent a market correction large enough to force compromise, the two sides will not agree on the starting point for tax rates."
Knapp nails it a number of times including his dismissal of 'survey's versus market positioning - just as we have been arguing - and as he concludes: people may have been expecting this outcome but they certainly weren't positioned for it.
Within the equity market in the near-term we believe there will be nowhere to hide. Stocks with high dividend yields are likely to come under pressure as President Obama and Harry Reid renew their push to raise taxes on upper income filers taking the 15% dividend tax rate up as well. While some of the recent domestic consumer related data has improved, the market is not discounting the risk of a tax hike and economically sensitive sectors seem likely to take a hit as well.
In the longer term, while U.S. growth has proven resilient to confidence shocks, it remains constrained by policy uncertainty and balance sheet deleveraging. Financial repression has limited the Fed’s effectiveness, rendering it counterproductive as inflation volatility rises and multiples fall. We believe a period of significant equity market valuation improvement can’t begin until the Fed initiates the exit strategy process, which is unlikely to occur until Federal government debt sustainability is addressed.
The election scenario that unfolded was the one with the most risk, the status quo outcome. Thus, while some observers might argue that there will be no “lame duck” session of Congress, since the major players will all keep their jobs in the 113th Congress, there also seems to be little basis to believe that a grand compromise is in the offing. We see little reason to increase the probability of avoiding the tax cliff or brinksmanship over the debt ceiling, or to expect pro-growth tax and entitlement reform in 2013.
Although we’re less confident in a positive turn in the data than we were in 2010 or 2011, we are confident the portfolio balance channel will remain heavily utilized by the Fed. If stocks with bond-like characteristics – defensives, high dividend payers and the largest cap – get hit on the risk of higher dividend tax rates, we would add exposure. Given risks around the tax cliff we would avoid economically sensitive sectors unless they cheapen considerably.
Status quo it is.
Following the launch of QE3 (QE Forever) we wrote that for equities to extend the monetary policy easing anticipatory rally either the economic or public policy outlook would need to improve. We believe a long-term period of sustainable equity market multiple expansion requires monetary policy normalization, which is unlikely until key public policy concerns – tax and debt sustainability via entitlement reform – are settled. The 2010 midterm election provided a short period of improved investor sentiment around those issues however, in our view; the 2012 election has had the opposite effect. We believe that for these crucial fiscal issues to be addressed, in a perhaps even more polarized political environment, the market will probably need to play a central role. With that in mind we cut our 2012 price target for the S&P 500 on Wednesday back toward a level we consider fundamental fair value
So, while some might argue there is no ‘lame duck’ session of Congress, since the major players all will serve in the 113th Congress, it also appears that there is little basis to believe a grand compromise is in the offing. With a polarized federal government we see little reason to increase the probability of avoiding the tax cliff, brinksmanship over the debt ceiling that has already been reached or enacting pro-growth tax and entitlement reform in 2013, by what appears to be the equivalent of a fragile coalition government.
Two more charts of interest...
Business confidence has again dropped, diverging sharply from consumer confidence, leading to a sharp contraction in capital spending... We have seen this before!!
and the market is entirely not positioned for the kind of political uncertainty that is currently ahead of us...
so what's an investor to do...
In the near-term, we suggest generally cutting risk.
We would not be tempted to add risk to economically sensitive sectors, particularly not the QE2 roadmap such as the commodity plays (metals and mining, energy) or weak dollar beneficiaries (industrials, technology), unless they cheapen considerably.
An abundance of hope (green lower panel) in strategist's forecasts for S&P 500 performance... but 2012 appears to have reverted them to reality a little - though dispersion is extremely high.
Meanwhile, year-end 2012 forecasts (that's less than 2 months away) are topped by Jonathan Golub at 1525 for UBS, Credit Suisse's Andrew Garthwaite at 1500 , Weeden's Chris Harvey at 1492, and HSBC's Garry Evans at 1490
Source: Bloomberg and Barclays