A Reasonable Prediction About This Year’s Stock Market

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After a shaky start to the year with markets down in January and the first 10 days of February stocks have rebounded nicely. And the S&P 500 index has made it back into positive territory—up!—about 1.5% or so year-to-date, but still down from this time last year.

With first quarter earnings mostly in (and disappointing results from many large retailers), many are now questioning the strength of consumer spending. But economic data from last week showed that it’s not all bad news on the consumer front because April’s retail sales figures showed a 1.3% increase, which was notably higher than expectations. Likewise, the latest reading of consumer sentiment rose from 89 in April to 95.8 in May, its highest level in 11 months. So economic data suggests that the consumer sector remains fairly healthy despite first-quarter earnings struggles at major retailers and energy companies. And with consumer spending driving two-thirds of our economy, things don’t look too bad going forward.

In addition to bullish trends in consumer spending, there are other reasons to be optimistic about the economy and the stock market.

So let’s look at the pros and cons as Bob Doll sees them. Bob is a well-respected industry veteran and is Chief Equity Strategist with Nuveen Asset Management.

On the positive side:

1. Equity values—stock prices relative to earnings—do not appear to be stretched. In other words, stock valuations, for the most part, are fairly in line with corporate earnings. And because valuations are reasonable, we’re unlikely to see sharp corrections associated with stock bubbles. I agree with that.
2. Earnings improvements should start to materialize in the coming quarters. The first quarter is often seasonal, impacted by a wait-and-see attitude by corporate executives before they make large capital spending decisions, and is where winter weather often plays a role in economic growth and earnings. But with positive economic data beginning to flow in and with strengthening consumer fundamentals, corporate spending and earnings should start to look up in the coming quarters.
3. The oil rout appears to be over. Remember how oil prices kept falling down to about $26 per barrel just three months ago in early February? Well, prices have almost doubled since then and crude is now close to the $50 level, at a six-month high, and that’s been a major boon pulling the beleaguered oil and gas industry out of a dangerous slump that severely impacted stock market sentiment, capital investment, and jobs earlier in the year. And the good news is that with oil back up again, the markets too have gotten out of their February slump.
4. Investor sentiment may be overly bearish, and I can tell you that almost everyone who walks in my door is bearish and waiting for some major bad thing to happen. And this ties into my earlier point: That equity valuations do not appear to be stretched and, in some cases, shares of good solid companies are trading at enticing discounts. Case in point, over the past few months, one of Buffett’s two major money managers within Berkshire Hathaway has built-up a $1 billion position in Apple stock, which was hurt by overly bearish sentiment to the point where those managers at Berkshire saw good value.
5. Bob thinks corporate tax reform prospects for next year appear bright, so that too should boost corporate sentiment and spending…which, in turn, translates into more jobs, higher wages, better consumer sentiment, and economic growth. How he can tell this based on the current presidential candidates’ statements is a mystery to me, so we will see how this plays out.

But as I stated in one of my earlier commentaries, with the stock market there are always risks, as one type of risk rotates out and another rotates in to take its place.

The negatives include:

1. The fact that Q1 earnings were shaky means investors are now taking a wait-and-see approach for tangible improvements in earnings before they overcome their bearish tilt and get bullish again.
2. Investors may be overly complacent about Federal Reserve rate hikes. So the Fed’s been overly accommodative with its monetary policy, which is another way to say they have kept interest rates incredibly low. So investors have gotten used to a regime of low interest rates. But low-interest rates are unlikely to last forever, and if economic data strengthens, investors could be caught unawares by a series of sharp rate hikes… and this could drive up volatility. That said, I doubt that Janet Yellen and her team will rock the boat. So, for the foreseeable future, rate hikes will likely be well-signaled ahead of time, so markets take them in stride.
3. Global growth is likely to remain anemic. While the U.S. economy has proven its resilience time and time again, our major trading partners remain mired in an economic slump, with no clear signs that they will pull out anytime soon. And if global economies continue to stay down over extended periods of time, we could well catch their contagion because many of our corporations derive a healthy share of their profits from international operations and may not be able to grow earnings at levels that justify their stock valuations. So global economic weakness is a real and present risk.
4. The U.S. political backdrop is highly uncertain. It’s anyone’s guess how this year’s presidential election is going to play out, with Clinton and Trump in the lead, but Sanders a wild card. November’s election outcome—Democrat or Republican—will impact markets. As you know, markets don’t like uncertainty, and this year’s presidential election is anything but certain.

So Despite a Solid Outlook, Sentiment Remains Depressed
Volatility has been the theme that has dominated markets in 2015 and 2016. Markets pulled back over the past several weeks after rallying from mid-February through mid-April. Investor sentiment has remained weak and investors are defensively positioned, continuing to hold large amounts of cash. So while investors may believe that conditions aren’t as dire as they thought early in the year, they are hardly optimistic about earnings and economic growth prospects.

Overall, I think the positives will win over the negatives, as they typically do, but near-term concerns could keep stocks from moving up in a straight line. Ultimately, investors will need to see evidence that corporate earnings have recovered before they feel comfortable moving back strongly into equity investments, and this evidence should materialize over the coming quarters, which is why equities will likely outperform bonds and cash over the next 6 to 12 months. So says Bob Doll.

Thanks to Bob, and remember to sign up for our weekly update to make sure you don’t miss anything important. We are also on Soundcloud, we podcast, and you can follow us on Facebook and Twitter.