Following a series of disappointing global economic data that was recently topped off by Friday’s disastrous U.S. employment situation report, the new economists’ consensus is that the Federal Reserve will announce a new round of easy monetary policy at the end of its June 19-20 Federal Open Market Committee meeting. This is good news for those who were worried that stocks would tumble without active Fed-sponsored accommodation.
Even so, Barclays’ Barry Knapp cautions against getting too excited too soon. “Although the market has begun to look to the Fed for stimulus, equities will likely be much lower before the policy put is exercised,” wrote Knapp in a Friday note to clients.
More from his note:
With one month left in the Fed’s 3rd stimulus program, the equity risk premium (ERP) is again expanding toward levels reached last summer. ERP retracements following the end of QE1 and QE2 were greater than 100%; a similar move appears to be underway…Using history as a guide, our ERP scenario analysis places the downside potential for the S&P between 1,100 and 1,200.
Photo: Barclays Research
However, Knapp is sticking to his call for the S&P 500 to end 2012 at 1,330, which implies a 12.9 price-earnings multiple on $103 EPS.
He identifies some factors that could provide some support to the markets and perhaps provides a catalyst to an upside move. From his note:
So, with the near-term outlook having significantly weakened, there are two potential reactions that could slow the inevitable decline in equities, that is after measures of risk like implied volatility, the term structure of index volatility and correlation all approach 2010 or 2011 levels, with the equity market hitting our downside target (at least 1,200). The potential shock absorbers are (1) Fed stimulus, which we believe will ultimately prove ineffective (but could help sentiment in the short term), and (2) a continued shift in the polls towards a new CEO of USA, Inc., which could set the stage for resolution of the core issues contributing to weak investment.
Regarding that latter point, Knapp thinks that we may want to start thinking about the possibility of a leadership change-related rally. From his Friday note:
This morning’s payrolls number may increase the probability of a significant change in Washington come November (with a potential end to gridlock). While it may be too early for the equity market to discount this outcome, today’s employment report makes the 1980 scenario (a stock market rally despite a bad macro environment) increasingly likely, in our view.
Indeed, we recently learned that President Obama’s re-election odds have been sinking.
1980 was when Ronald Reagan was voted into the White House. Here’s how stocks did that year:
Photo: Google Finance