Equity ratios trigger alarm bells
• S&P 500 Index has stayed higher for longer only twice before, each time ending with crashes
Valuation, history shows, is an awful tool for market timing. Equity cycles persist, and selling just because price-earnings ratios are high has repeatedly proven a mistake. But what if the persistence starts pushing up against history? Consider the S&P 500 Index, which has spent 42 months trading in the upper reaches of one range, the cyclically adjusted price-to-earnings ratio. Only twice before has it stayed higher for longer, each time ending with crashes, in 2000 and 2007.
To say this is not bothering investors would be an understatement. About $2-trillion has been added to US share values in eight weeks, with price momentum in the Dow Jones Industrial Average at levels not seen since the internet bubble. Bulls, firmly in charge, are convinced Donald Trump will inaugurate a cycle of profit growth that reins in valuations. Maybe. But to get where bulls think earnings are going, the economy would have to pull off a feat of strength that is unprecedented since at least 1937. Specifically, on the three occasions the US has gone seven-and-a-half years without a recession, earnings have never grown 10% this late in the cycle.
That is the rate analysts estimate for the S&P 500 in 2017.
“Just because you have any high multiple level doesn’t mean you can’t stay there for some time,” said Jerry Braakman, chief investment officer of First American Trust in Santa Ana, California, where the firm oversees about $1bn. “But a lot of averages do come back and haunt you.”
Here are my pick of the comments and predictions for 2017:
● Wall Street strategists surveyed by Bloomberg forecast the S&P 500 will rise to 2,356 in 2017, a level that represents a 4% increase from the last close. Bloomberg Markets
● … beware of analogies between 1981 and 2017 when stocks took off under Ronald Reagan. Interest rates were historically
high and set to fall for several decades. The opposite is true now. Stock market valuations were orders of magnitude cheaper than they are now, too. Global Macro Strategy
● 2017 may be the least certain in years, with higher-than-usual risks and a binary set of outcomes that have dramatically contrasting results: euphoria or fizzle, significantly higher or lower than the base case. We see potential for big market swings ... 2017 could be a binary year when the market falls to 1,600 in the bear case and rises to 2,700 in the bull case. Bank of America Merrill Lynch
● Despite the potential for more volatility, we expect the bull to celebrate its eighth birthday in March 2017. No recession is in sight, for now. However, the old saying ‘three steps and a stumble’ could put stocks to the test when the Fed hikes again after a hike this December. UBS
● Following recent improvements, we expect macroeconomic advances to continue in 2017. This could bode well for top-line growth opportunities and the earnings outlook for emerging-market equities. We believe that, while the economies of Russia and Brazil are still contracting, they are on an improving trajectory and could significantly influence the growth rate of the whole group. Meanwhile, China’s growth, which has been a key concern for many observers, has shown signs of stability and remains at a strong level compared to most other large economies. In the third quarter of 2016, the country’s year-on-year growth in GDP came in at a rate of 6.7%, in line with the pace reported in the previous two quarters.
Overall, we expect to see GDP growth for emerging markets in 2017 at a solid and accelerating level, markedly above the rate expected from developed markets … as a group, manufacturing economies are generally back into a position of current account surplus, while there has also been headway in bringing down the deficits of commodity-exporting countries. The debt-to-GDP ratios of emerging market countries are generally below those of developed markets, providing a more stable and sustainable economic foundation. Finally, interest-rate differentials between the two groups are wide, giving emerging market central banks greater flexibility to manoeuvre, if required, in the future.
In terms of valuations, the MSCI Emerging Markets Index has traded at a significant discount to the MSCI World Index, for example, on a price-to-earnings-multiple basis. Although we are mindful of the potential for volatility and watchful for the risks, we believe sentiment toward emerging markets could continue to become more positive. In our opinion, the search for higher yields and improving risk perception toward emerging markets, helped by robust economic tailwinds, could provide a basis for further strength in emerging market equities. Templeton Emerging Markets Group
● Asian equities ex-Japan represent the best opportunity with a potential return of roughly 12%. Goldman Sachs
● We are especially bullish [about] commodities for 2017. The oil market is treading water for now, but the oil price overshot to the downside earlier this year [2016] and this is clearly setting the stage for a bullish end to the decade. Global raw material demand still continues to grow, helped by the US and China, while supply cuts are showing in petroleum and North American natural gas, some base metals and farm products…. Unlike last year [2015], when commodity markets rallied through the second quarter only to fall sharply come the third as oversupply persisted, this rally looks more sustainable as physical markets have tightened considerably. Global demand continues to grow at a moderate rate while the pullback in capital spending is reducing not just supply growth but total supplies across nearly all extractive industries. Citigroup
● Where do we see the price of gold going in 2017? We start sensing that gold will continue to act as a “fear asset” in 2017. Given that stock markets, which we consider an important risk indicator, are becoming very bullish gold could take a hit as fear is moving away from markets. In the early days of 2016, markets were driven by fear, which is the reason gold rallied so strongly, but that has changed recently. With that in mind, we see gold moving towards the lower area of its bearish trend channel. Right now, support comes in around $990. By the second half of 2017 that will be around $890, where it peaked in 1980. In other words, we do not exclude the scenario in which the gold price will hit $890 in 2017. InvestingHaven.com
● [But] with change always happening in times of crisis, 2017 may be a wake-up call which sees a real departure from the “business as usual”, both in central bank expansionism and government austerity policies which have characterised the post-2009 crisis. Saxo Bank
WHILE THE ECONOMIES OF RUSSIA AND BRAZIL ARE STILL CONTRACTING, THEY ARE ON AN IMPROVING TRAJECTORY