January 7, 2017
On Christmas Eve 2015 I posted a set of ramblings, questions and predictions heading into 2016. With a series of thoughts I have accumulated since early December as a baseline, I will attempt something similar in this post.
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Secular Bull Market?
Among others (Jeff Saut, for one), the great market research firm Ned Davis Research believes we are in an equity secular bull market that will see double digit gains thru the end of the decade, at minimum. As market technicals form the core of their ‘being’, a big driver of the secular bull market thesis is how the market has ‘behaved’ since the March 2009 lows – 15%+ gains per annum with ‘higher highs’ in multiples on the back of improving macro conditions. Valuation is largely ‘backed and filled’ in order to fit the Macro + Technicals ‘weight of the evidence’ conclusion.
GMO and John Hussman best represent the view that the US equity market is severely overvalued based on historical valuation metrics. One additional piece of evidence in their support is the fact that the % of respondents in the monthly BAML “Global Fund Manager Survey” that believes the equity market is overvalued is at record highs. As the BAML “Thundering Word” team likes to say, the equity market is currently dominated by “fully invested bears” (paraphrasing a bit).
Secular bull market believers tend to cite the S&P 500 forward price/operating earnings and/or the spread between equity earnings yields and bond yields. It is semantics, as the burden of proof is on the ‘perma bears’, but I do not agree with these valuation metrics. IMO, the most rational arguments for ‘this time is different’ wrt valuation are tax rates and inflation. As long as the macro backdrop is accomodative to equities, current tax rates remain in place and/or trend lower, and inflation remains tame (sub-3%?), a 17.5-22.5x market PE is likely a fair range.
As a rough gauge, the Value Line median PE closed Friday at 19.6x.
To partially answer the original question, I believe too many global macroeconomic factors must ‘thread the needle’ for the market to see double digits gains thru the end of the decade. So while NDR is more than likely correct that we have been in a secular bull market since March 2009, I believe they are likely wrong in the duration of their call. Sometime in the 2017-2019 period I believe inflation, interest rates, and thus the Fed will become hostile to US economic growth, and the US business cycle will turn south, leading to a de-rating in the US equity market.
This is a relatively lighthearted prognostication piece – so for fun, a rough outline of a possible path for the S&P 500 thru 2018…
S&P 500 Path thru 2018
As I have outlined via multiple mediums – and will do in greater detail in an upcoming post via the 17 Mile Seeking Alpha account – I believe the current market backdrop is very much akin to the early stages of the 2013 bull market. But unlike 2013, valuations, inflation, interest rates and the Fed pose a considerable headwind once the market completes its rally. As such, I believe there is a material probability that the market makes its final peak in the first 6-9 months of 2017 before descending into a cyclical bear market that de-rates the market down to at least 15x earnings (or ‘at most’, depending on the semantics).
The SPX closed Friday at 2276.98. Using the Value Line PE of 19.6x as a rough market proxy, were the S&P 500 to rise to 22.5x earnings it would have to rally by 14.8% to 2613.88. I believe a rally into a “Short in May” season makes sense; but another possibility is that market ‘breadth’ peaks in 1H17 while the index itself doesn’t peak for another 2-3 months (akin to the 1987 peak).
If the Fed begins to aggressively respond to rising inflation – via action and rhetoric – and the US economy heads south in late 2017/early 2018, then the S&P 500 de-rates to 15x, or -33% to 1742.59. Perhaps a recession somewhere between the magnitude of 1990 and 2000-2002, and a 6-9 month equity bear market into early/mid 2018?
Again – all in good fun. This could easily be the exact opposite of how things play out over the next 12-18 months. What I firmly stand by, however, is the current bullish market configuration along the lines of early 2013.
Stocks & Sectors
- Bit of a rollover prediction from 2016, but Media is a good place to be in 2017.
- I said on 12/5/16 that the T/TWX deal was a spark, and that once fund managers entered a new year buying would begin…let’s see if there is follow-up to this week’s price action.
- Broadly, probably want to own everything but VIAB and DIS…but have a feeling I’m simply biased against DIS.
- The Dolans are not dumb – I think they make a move with MSGN as industry M&A heats up in 2017.
- Continue to firmly believe that 2017 is the “year of DISH” with the Broadcast auction coming to a close.
- After a necessary reset in the ‘Malone trade’, LBTYK has been out of the daily spotlight for awhile now (often a necessary condition for a ‘bottom’) and is likely a sneaky-big 2017 winner.
- On 12/5/16 I said: “I want to be more enthusiastic about the potential “Dogs of the Dow” 2017 Spec Pharma trade. For some reason I can’t get there. Perhaps that’s a good thing.” (A ‘good thing’, meaning that I was likely playing my own contrarian indicator.)
- This week’s Drug stock price action exhibited all the signs of a blown out industry ‘taking off’ in a new year; but I am open to a final round of new lows.
- TEVA’s puke yesterday was a big buying opportunity, IMO…
- After seemingly daily attention paid to its declining stock and management’s ‘lack’ of M&A initiative, like LBTYK, GILD is now out of the spotlight and likely set for a big 2017.
- Is PRGO bought out in 2017, or at least approached?
- BAC/BRK is a great long-term ‘reflation’ combo, but…
- …Short- to medium-term sentiment is overly extended for the Fins, KRE insider selling is robust, and the bond market has exhibited signs of short- to medium-term selling exhaustion.
- A BAC/BRK trim/JNJ add trade makes sense into perhaps the end of 1Q17?
- JNJ is an interesting healthcare/staple combo, so it should benefit from a Pharma + bond market rally.
- In December 2015 I asked if we would get a shot at AAPL below $85 in 2016 (it got to $89.47). Let’s roll that forward and ask if we see sub-$80 if AAPL continues to do nothing to diversify its earnings power…
- IMHO, the stock is cooked.
- Everyone and their brothers and sisters are enamored with AMZN’s effectively unlimited growth runway. It’s time for a bout of questioning Bezos.
- I look forward to considering a long position below $600 🙂
- Does KHC make a move before rates move too far too fast?
Black Swan Required?
It’s always interesting to put together a list of potential ‘black swans’…but more often than not the equity market ‘breaks’ due to market participants not appropriately accounting for a ‘risk’ hiding in plain sight. At present, rising rates, rising inflation, and a more hawkish Fed are viewed positively as signs of accelerating economic growth and thus corporate profitability. I will play the market as it lies, but I believe this monetary triumvirate will more than likely be the source of an equity market ‘break’ later this year.
For fun, my 2017 black swan pick is increased military aggression out of China. #MAGA.
DISCLAIMER: The views and information I provide are for informational purposes only; are not meant as investment advice; are subject to change without notice of any kind; do not constitute an offer of products or services with regard to any fund, investment scheme, or pooled investment; nor do they in any way, shape or form represent the views of my employer.