Mike Gibbs, Managing Director of Equity Portfolio & Technical Strategy, discusses how current economic conditions may support a bullish bias for equities.
Over the past 30 days, the S&P 500 has weakened as the odds of a Fed rate hike in December increased and the U.S. presidential election begins to weigh on investor emotions. Recent economic reports such as ISM manufacturing, ISM services, Housing data, non-farm payrolls and retail sales, although mixed relative to consensus, have all been supportive of a generally expanding U.S. economy. The reports along with the FOMC minutes and recent general Fed commentary suggest that outside of an economic set-back or new global unrest, the Fed is likely to hike rates in December. Current odds have reached the upper 60% area in recent days.
The current equity market weakness appears to be an opportunity for investors. Economic growth – albeit slow – is supportive of a bullish bias for equities, earnings are expected to resume growth in 2017, central banks have signaled loud and clear they will step in at any hint of economic weakness, and, once the elections are over, the odds of fiscal stimulus appear high. For this reason, equities should be well bid in the period just ahead. Although downside appears limited, there remains enough uncertainty to limit upside as well. Buying pullback periods is the best course of action to add additional return to equity portfolios in the current environment.
The U.S. election continues to drag through the political sewage pile as old videos, personal attacks and email releases dominate the headlines while discussion of the issues and how each party intends to address the issues gets way too little coverage. Such is the current electoral process. With Clinton well ahead in the polls, some investors have contemplated what a clean sweep by the Democrats might mean. With economic growth already weak, a democratic sweep might prove most problematic economically. Higher taxes and even more regulation are not what a slow growing economy needs. Granted, a push to spend on the fiscal side in the Democratic plan would be welcome for the economy with the monetary side running out of effectiveness. Yet, with a focus on public infrastructure, the boost to GDP is likely to be a slow process due to bureaucratic government channels. Also, the $275 billion sought over five years would equate to approximately 0.30% additional GDP growth by many estimates we have seen. Luckily, the odds of the Democrats sweeping the House are low. Nevertheless, in this odd election season, anything seems possible. With several weeks to go, the polls are likely to move around a lot and are likely to influence investor opinion and confidence, or lack thereof.
Not only are investors dealing with the guessing game regarding the Fed and the election, they are also digesting Q3 earnings reports. Although earnings for the quarter are expected to be down year-over-year for the sixth quarter in a row, an anticipation of a turn higher in Q4 and into 2017 will place heavy emphasis on company guidance. With economic conditions in the U.S. likely to remain supportive of earnings improvement, the general tone coming out of earnings season is likely to lend support to the equity market.
Technical weakness, which began with a price breakdown on September 9, leaves the impression stocks are, at least, unlikely to stage a meaningful rally over the near term and more likely to continue to experience weakness. Despite this, we do not feel the odds are high stocks are in for a meaningful move lower in the very near term. Internal and broad-based technical strength at the recent market high influences the opinion. We continue to focus on an area near 2120 down to somewhere near the 200-day moving average (~2068) as potential support. On the upside rallies will likely be contained by the 50 day moving average (~2164) up to the old high (2193). From the September 14 close at 2132 the risk vs. reward is evenly matched at ~+3% to ~3% for the very near term.
Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc. and are subject to change. Past performance is not an indication of future results and there is no assurance that any of the forecasts mentioned will occur. The S&P 500 is an unmanaged index of 500 widely held stocks. Asset allocation and diversification do not guarantee a profit nor protect against a loss. Material prepared by Raymond James for use by its advisors.