Yesterday JPM, which despite calling for a 2,200 year end price target, paradoxically warned that the regime of "buying dips" is over, and that "we take the view that equities are unlikely to perform well on a 12-24 month horizon" adding that "the regime of buying the dips might be over and selling any rallies might be the new one." So don't buy dips yet somehow the S&P will rise 150 points? Fair enough.
Today, it is Citigroup's turn to try to somehow predict both a 12% "gain for global equities in 2016" even as it tells clients to start selling US stocks because "fading EPS momentum and rising Fed funds mean that, after 6 consecutive years of outperformance, we cut the US to Underweight."
In short, Citi is now a "tired bull." Here's why:
We think that this global market, which began back in March 2009, is ageing but not finished. Citi strategists forecast a 12% rise in the global index in 2016.... With equity valuations reasonable, our main concern is the EPS outlook. Top-down, Citi strategists expect global EPS to grow by 7% over the next 12 months, consistent with our economists’ current forecast of 2.8% global real GDP growth. Willem Buiter’s feared 2.0% outcome would suggest a contraction of 0-5% in global EPS.
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Weaker EPS momentum and rising Fed funds mean we cut the US to Underweight. We remain Underweight the UK and Australia and Neutral EM.
If not the US then where:
We favour Europe ex-UK and Japan where central banks are supportive and EPS momentum reasonable. We maintain a mildly cyclical sector tilt, with Financials being the most consistently favoured sector across the Citi equity strategy team.
Ah yes, the good old "central bank support" - the only driver of stock upside since 2009.
What about the most important "fundamental" of all: earnings? Citi's summary: "more downgrades likely"
A slowing world economy is proving a drag on EPS. Figure 7 shows that, after growing 5% in 2014, trailing MSCI ACWI EPS fell 6% in 2015. Behind this is a story of shifting leadership. Weaker currency regions such as Japan (+9%) and Europe ex UK (+1%) saw gains in local currency trailing EPS over 2015. But the US and UK suffered falls of -7% and -16% respectively (Figure 8). Both markets saw EPS hit by currency strength and sharp drops in commodity company profitability. The story in EM is split, with EPS contracting sharply in commodity-heavy CEEMEA and LatAm but holding up better in Asia.
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Then there is the credit/equity cycle, where the bull is not just tired, he is "aging"
Credit/Equity Cycle: Ageing Bull
Another concern is the ongoing rise in global credit spreads. Over the past 18 months, it appears that asset markets have shifted into Phase 3 of Matt King’s credit/equity clock (Figure 13). Equities can continue to perform even though credit spreads are rising. It is different to Phase 2 when equities rise and credit spreads fall (Figure 14). It is also different to Phase 4 when both equity and credit sell-off sharply. It seems that we are now well into Phase 3 of the US credit/equity cycle although the ECB is trying to hold back the progression of this cycle, in the Eurozone.
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In Phase 3, the bull market is old but not dead. In previous cycles, this period has lasted up to 3 years (this one is now 18 months old). Past cycles have seen some common characteristics which seem increasingly evident now: corporate releveraging, rising market volatility and growth beating value strategies. They can also produce equity market bubbles. Investors should be wary of fighting strong momentum trades at this point in the cycle. They can get much more expensive than anyone would expect.
Markets typically head into Phase 4 (bear market in both credit and equities) when US HY spreads get too high (700bp+, currently 690bp) and the global profit cycle turns down sharply. This means that HY spreads are a major concern for us, although it is reassuring to see that Citi credit strategists are expecting widening to halt in 2016.
Others, such as JPM are not quite so sure, as we showed yesterday in The Best Leading Indicator For Recession Is Flashing Red, JPMorgan Warns [17]: "JPMorgan notes that in fact the three best leading indicators for recession are: Credit spreads, yield curve shape, and profit margins. Unfortunately for The Fed and its congregation, JPM warns credit spreads are not giving a positive signal."
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To be sure, Citi is not all negative, and notes that, according to its models, "valuations are not stretched" (others beg to differ, of course).
The MSCI AC World benchmark currently trades on a trailing PE of 18x, slightly above the long run median of 17x (Figure 16). Global equities don’t yet look especially cheap (they hit just 12x in the Eurozone crisis), but they are not especially expensive either.
The US trades on the highest trailing PE (Figure 17). LatAm is not far behind given the collapse in EPS. Those looking for cheaper valuations according to this measure should focus on Japan, Australia or EM.
Then again to its credit, Citi's adds that "trailing PEs provided few sell signals in 2007, making investors suspicious of their worth. Instead, many now prefer to look at valuations based on average or trend EPS. Compared to spot PEs, these measures tend to make markets look more expensive when profits are high and cheaper when they are low. Unsurprisingly, they are popular amongst margin mean-reverters. We calculate the cyclically-adjusted PE (CAPE) that compares current share prices to the 10-year average EPS. The global CAPE is now 21x, so not expensive compared to a long-run median of 24x. Japan is the most expensive major market on this measure (26x). The US is second most expensive on 25x. Weaker EPS and share prices mean that UK and EM equities look cheapest, trading well below their longrun medians."
Taking this schizophrenic forecast together, in which Citi is bullish but not really, here are the banks' summary year end forecasts:
At the start of the last quarter Citi strategists’ market targets were suggesting 20%+ returns to end 2016. The subsequent market recovery and some target cuts mean that we now forecast a gain of 12% for the MSCI AC World Index over the next 12 months in local currency terms (Figure 22). We are most optimistic on Japanese, European and Asia Pac equities. Lower, but still healthy, increases are forecast in the US, UK and Australia.
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Finally, what according to Citi is the biggest risk:
Global recession remains the key risk to our reasonably positive view on equity markets. Willem Buiter worries that global real GDP growth could slow to 2.0% in 2016, well below our current house forecast of 2.8%. According to our models, Willem’s scenario would be consistent with a mild global EPS contraction of 0-5%. For a full-on EPS recession of more than 10%, we would probably need to see GDP growth drop below 1.5%.
Figure 23 shows the relationship between global share prices and future trailing EPS. At any time the level of the MSCI ACWI benchmark seems to reflect investors’ expectations of where EPS will be in 9 months’ time. Those expectations have usually been pretty accurate. For example, at the end of the last bear market (March 2009) share prices bottomed 56% below their 2007 high. Sure enough, trailing EPS eventually troughed 58% below their previous peak. The Eurozone crisis of 2011-12 scared investors into discounting a double-dip in global EPS. When that failed to occur, share prices quickly recoupled with the earnings base. Indeed, it seems that they even moved on to discount decent growth. However, with that remaining elusive, global equities are now struggling to sustain gains. Even with continued support from very low interest rates, we suspect that any meaningful drop in EPS would be difficult for share prices to withstand.
So, S&P at 2,200 on December 31, 2016... unless the global recession forecast by another Citigroup economist strikes, in which case look for something about 50% lower.
Got it.
