With global stocks suffering a bout of unprecedented volatility in the past two months, and the S&P routed by not one but two corrections in 2018, traders have been understandably shaken - and in many cases stunned - by a market in which nothing seemed to be working for the first 11 months of the year (although now that the US-China trade war has been put on hold for the next three months, we may yet see a burst of year-end euphoria as BTFDers come out in force).
However, not even the most jittery market since the financial crisis, one which saw virtually every major asset class generate barely any positive returns in 2018, and most were sharply lower...
... has managed to sap the sellside analyst crew of its traditional optimism.
According to Bloomberg calculations, of the 14 forecasts for 2019 from firms it tracks, the average prediction as of Nov 30 is for the S&P 500 to rise 11% to 3,056 by the end of next year. And while the steepness of the forecast path partly reflects the damage done to stocks since September, it’s the most optimistic call since the bull market began in 2009, according to Bloomberg's Lu Wang.
This chronic sellside resilience contrasts with sullen investor mood, where as reported previously individuals are raising cash at the fastest pace since the financial crisiswhile hedge funds are rotation out of growth names and turning all-out "defensive."
Countering the growing investor paranoia which has had the market rug pulled from under its feet on every occasion a consensus emerged to buy the dip, Wall Street analysts claim that despite the rout over the past two months, there is little evidence that a market crash is looming. Indeed, while overall economy growth is decelerating - in some cases sharply - corporate profits are still expanding. As a result, while the threat of a trade war and higher interest rates is real, the fear has probably gone too far, as reflected in a steep decline in valuations, according to Credit Suisse’s Jonathan Golub, who has the most optimistic target at 3,350.
Well, yes and no.
With the S&P P/E multiple shrinking to about 16.0x forward EPS forecasts, the S&P 500’s multiple is down 15% from a year ago, and while it is near the cheapest level since early 2016, it is still well above its long-term historical average. Also, while in 2018 profits jumped almost 25% - even as stocks are just 3% higher after last week's furious rally - profit growth is expected to grind to a crawl in 2019 as Trump tax cuts are anniversaried and as the global economic slowdown and the fading of the Trump fiscal stimulus turns into a headwind.
"We have pretty strong valuation support for the market. I think investors are too bearish," Palisade Capital Management CIO Dan Veru told Bloomberg; his view is one of the more extremely bullish heading into the new year: "They are taking these near-term headwinds, drawing a straight line, and given how long this expansion has been in place, saying this has to be the beginning of the end. My view is, we’re in the fifth inning of a nine-inning ball game."
Not everyone agrees: Mike Wilson at Morgan Stanley has the least bullish forecast for 2019, and expected the market to be unchanged this year, with a year-end target at 2,750. Echoing what we noted above, Wilson expects the pace of profit expansions to slow to just 4.3 percent, an 80% drop from the 25% growth seen this year; he also sees the odds for a technical recession rising as global demand weakens. In fact, Wilson did not mince his words, and two weeks ago said that the S&P is now officially in a bear market, as buying the dip no longer works.
Elsewhere, Bank of America’s Savita Subramanian no longer sees the S&P rising next year. As we reported two weeks ago, the BofA strategist expects upside to equities through year-end and into next year and thus maintains her 2018 year-end target outlook for 3000 on the S&P 500 as a result of "still-supportive fundamentals, still-tepid equity sentiment and more reasonable valuations keep us positive."
But in 2019, BofA now sees elevated likelihood of a peak in the S&P 500; not helping is BofA's rates team calling for an inverted yield curve during the year (same as Goldman which expects the yield curve to invert in the second half), and with homebuilders peaking about one year ago and typically leading equities by about two years, the bank's credit team is forecasting rising spreads in 2019.
"We suspect that we see a peak in equities next year, but bearish positioning and weak sentiment in stocks present upside, especially if trade risks subside, keeping us constructive for now," Subramanian told clients in mid-November. As a result, Subramanian is urging investors to buy utility stocks as a hedge against market declines. She expects the S&P 500 to linger around 3,000 before retreating to end the next year at 2,900, down 100 points from its 2018 closing level.
BofA's chief investment strategist, Michael Hartnett, is even more pessimistic expecting "big lows" in the market over the next few months as "the era of excess returns in bonds and equities has ended"...
... while the continued shrinkage in global central bank balance sheets will only add to the rising headwinds.
Meanwhile, in the aftermath of the biggest selloff in years, a sense of caution is creeping up even among the optimists. As Bloomberg notes, even the biggest bull is turning a bit defensive: Jonathan Golub at Credit Suisse this week downgraded cyclical stocks such as banks, industrials and materials producers while raising recommendations for companies seen offering stable income and dividends, like health-care and consumer staples. He expects the S&P to rise almost 600 points by December 31, 2019 from its Friday close, hitting 3,350.
What is more surprising, is that despite his headline optimism, reading between the lines of Credit Suisse forecasts one would be left with the impression that a recession is imminent: the bank shows that the market historically stops gaining about 6 months ahead of a recession...
... while on virtually all occasions since 1968, a bear market has been associated with a recession.
Still, with the exception of Morgan Stanley, all strategists remain optimistic and expect stocks to go up next year from where they are now. Yet underneath the buoyancy, a gap is widening. At 22 percent, the spread between the highest and lowest forecast is the widest since 2012.
Of course, anyone listening to the "strategist siren song" should be aware of their perpetual propensity to enter the new year bullish: after all clients will trade more if they are optimistic, not if they anticipate a crash. Since Bloomberg began tracking sellside reco data in 1999, professional forecasters have never once predicted a down year, with the average annual gain coming in at 9%.
But before we even get to 2019, there are still four weeks left for 2018; the average sellside forecast is for the S&P to hit 2,942. And even after the best week since 2011, the S&P 500 would need to jump roughly 7% to get there, although this weekend's trade truce between the US and China may facilitate the release of animal spirits. Still, a 7% rally in the last month has only happened four times in the last 90 years.
Finally, for those who invest based on Wall Street recommendations, keep in mind that over the past two decades, chronically optimistic strategists’ track record is anything but perfect. While their bullishness looks prescient when shares are rising - as they have been for the past decade thanks to $15 trillion in central bank liquidity - the S&P 500 has exceeded strategists’ target by 4.4% points a year during this bull market.
That in mind, any investors who had listened to bullish sellside recommendations during the last two bear markets would have lost half of their investments. And with central bank liquidity now going into reverse, investors may