Market Strategy Radar Screen Weekly December 19, 2016

  Onward and Upward

We see further upside in 2017 though not in a straight line from here

That said, we believe that the effects of the stimulus agenda are not likely to be felt in the economy until such fiscal policies are enacted and are given some time to take effect.

We expect volatility in the currency markets as interest rates work their way through a process of price discovery relative to the pace of expected growth. These repricing episodes are likely to provide intermittent headwinds for stocks as diverse growth rates among countries and economic regions bump up against currency movements, changing expectations of monetary policy and fiscal policy regimes, which are in transition across the globe.

We arrived at our 2017 price target for the S&P 500 based on our expectations for a combination of earnings growth and multiple expansion as interest rates normalize moderately and investors pay more for each dollar of earnings growth.

We look for the S&P 500 to generate earnings of around $125 per share on which we place a P/E multiple of 19.5x to arrive at a price target of $2,450 for the benchmark in 2017.

Since the surprise outcome of the US Presidential election stocks have broadly rallied across the globe with the US markets leading the process.

As of last Friday the Dow Jones Industrial average, S&P 500, the S&P 400 (mid-caps) and the S&P 600 (small caps) had respectively advanced 12.72%, 9.44%, 18.02% and 23.69% from the start of the year. Just since Election Day the aforementioned indices have risen 8.24%, 5.54%, 10.2% and 15.98%.

Considering the challenges to the market in the first seven weeks of the 2016 or around the Brexit vote in late June, it is not surprising to hear investors ponder how much higher stocks can move before a catalyst appears worthy of a pause or even a pullback.

Just last week a spate of rotation in stocks that included some profit-taking among mid-cap and small-cap stocks saw the S&P 400 and the S&P 600 give back some of their recent gains as they respectively declined 1.49% and 1.8% on the week ending last Friday.

It’s worth noting that the S&P 500 (Large caps), which had lagged the mid and small cap stocks on a year to date basis and from the election day rally’s start, but slipped just 0.06%—signaling to us that last week’s selling was less about fear and more about year-end profit taking and rotation on the back of a year to date and postelection run-up.

Last week we noted that the post-election rally in stocks had seemed to us to have “turned bears into skeptics, skeptics into bulls and bulls into philosophers.” The equity market’s “give back and pause” action of last week saw a respective rightsizing among bears, skeptics, and bulls as they appeared to revert to their traditional stances.

At the core of last week’s action in the bond and stock markets was the Fed’s upward tweak of 25 bps to its Fed Funds range of 0.25-0.50%, slightly higher to a range of 0.50% to 0.75%.

Ironically most investors had expected the Fed to raise its benchmark rate by 0.25 bps at each end of the band range—but instead of rallying on the news investors sold stocks and bonds as they apparently focused on Fed Chair Janet Yellen’s comments intimating that the market might expect three rate hikes in 2017 up from earlier expectations of just two.

From our perch on the radar screen we recall the market “getting into a dither” at the beginning of this year when Fed Vice-Chair Stanley Fisher intimated that the Fed would raise four times in 2016. The Fed instead raised rates just once and was done for 2016 as of last Wednesday.

In the week ahead we look for market activity to slow in pace as the Christmas holiday weekend draws nearer and as denizens of the world’s trading desks head to familial destinations.

We expect that even as the year draws to a close the S&P 500 still has the potential to reach our 2300 price target for the benchmark which we initiated last year on December 22nd. As of the market’s close last Friday the benchmark was just under 2% below our target.

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