There is a pervasive bearishness in markets as investors and traders focus almost entirely on the negative aspects of the global economic, markets, and stock outlook.
That’s the message from Citibank’s chief US equity strategist Tobias Levkovich in his note to clients this morning. The way Levkovich reads it, the all-pervading bearishness, the flows, and the positioning that has resulted from it “argues for a near 97% chance of a higher S&P 500 by mid-2017”.
Levkovich says that talking to clients around the world has been tough lately “in the sense that almost every meeting involves discussing all the negatives out there”.
“A very recent conference call with overseas investors focused on the Fed’s new stance regarding a possible summer rate hike, profit margin pressures and high inventory/sales ratios, never once mentioning strong consumer spending data, impressive housing sales or the declines in the unemployment rate (admittedly with a disappointing May jobs number),” he said.
He’s happy to concede that not everything is going well but says the “crowd is definitely skewed to the negative”.
But, in the same way that even though we all think we are above average drivers, simple maths tells us we can’t be. So Levkovich says many investors are labouring under the misapprehension they alone are bearish or holding concerns for the market’s outlook.
“When we responded that (the client bears in meetings) anxiety, did not stand out and that they were part of the vast majority of worried people we meet or chat with regularly, they seemed almost offended,” he said.
Levkovich is not making an argument simply on positioning though and makes the case that stocks are near their highs because earnings are also near all-time highs and have been for some time. Only the drag of energy stocks knocking them back recently has changed that outlook.
Naturally such a view also argues that the market is fairly priced and Levkovich says recently he’s been asked about the impact of the Fed’s intention to raise rates and the impact on the economy and stocks.
On this he says that household debt service levels are extremely low by historical standards and as such, that implies “25 or 50 basis points of higher rates by year-end” would not be devastating for consumers.
He also highlights Fed funds increases “in the past 20 years have not been all that bad for stocks and the incredibly low current rates are the anomaly, not the norm”.
So there is room for stocks to stay strong and even rally.
When you throw in investor sentiment that is weak, strong outflows from stocks to bonds – “it is startling to see how much money has been pulled out of domestic equity mutual funds through May”, Levkovich says – and worries about the sustainability of corporate buybacks, the picture of almost universal bearishness is complete.
But Levkovich is no Pollyanna in his bullishness, he says. Rather, he describes his stance as “moderately constructive versus being resoundingly so”.
So he’s bullish but concedes that “the large number of skeptical investors and Fed rate hike concerns as probably limiting the upside potential to just matching the pace of earnings growth”.
“Thus, we remain comfortable with a 2,150 year-end 2016 target and a 2,250 mid-year 2017 objective.”
That’s around a 7% rally for US stocks, as measured by the S&P 500, over the next 12 months. If the ASX 200 can tag along for the ride, that will take the 200 index back above 5700.