FYI | May 22 2018
By Peter Switzer, Switzer Super Report
We could see 7000 on the ASX this year! Seriously!
Last week the big uplifting revelation for the week came on my Sky News Business program (Money Talks) on Monday, where CMC’s Michael McCarthy and Sharewealth Systems’ Gary Stone quite shocked me.
Being ridiculously candid, I reminded my two guests that before Donald got tweeting on trade, China and Iran, I’d speculated that we might see 7000 on the S&P/ASX 200 Index. So I hopefully asked them if economics and earnings could trump geopolitical stuff. Could we get to 6800?
But both, surprisingly, said they think 7000 isn’t completely out of the question for 2018! Sure, we have to see economics and earnings proceed as forecasted, but both 24/7 market watchers believe we’ve got a chance.
That’s great but what are the big end of town, US investment banks, seeing in their crystal balls? Clearly, we need Wall Street to keep climbing to give our market the momentum to go close to threatening the 7000-level, so let’s look at the strongest case for believing that my two mates are on the money.
The case for
A few months ago Citi showed us its indicators that warn them when a bear market is coming. Then the story was 3.5 signs out of 18 were negative for the bull market. These have been good at predicting the future, such that before the 2000 Dotcom Crash the score was 17.5 out of 18 and so they were screaming “sell and get out of the market”. When the GFC problems surprised money markets the score was 13/18. And remember there was a curve ball then as the hallowed credit ratings agencies were not quite accurate in their assessment of a pile of US home loans, so maybe the score should have been 14 out of 18 then.
At our recent Switzer Investment Strategy days an attendee/subscriber asked if I had seen the latest score from Citi? At the time, I hadn’t but I’ve since dug this up and this was reported in late April.
“Only two-and-a-half out of the 18 factors on Citi’s list are marked as ‘worrying’,” strategists including the company’s Robert Buckland wrote in a recent note to clients.
“The checklist would have helped us hold our nerve in 2011-12 and told us to do the same during sharp corrections in August 2015 and early 2016,” the strategists wrote. “Right now, it is telling us to buy this dip.”
That was April and it has proved to be right again. Citi says it’s not a market timing model but it certainly gives you good reasons to be relatively confident, cautious or scared about being long stocks.
By the way, the Citi team is not ignoring some warning signs, such as high-trailing price-earnings ratios, huge returns on equity right now and the slope of the bond curve, but, on balance, they remain believers in the bull market, for now.
The case against
Now for the more negative take on our stocks’ future.
According to CNBC, “Bank of America Merrill Lynch sees a scary good news-bad news scenario unfolding in 2018: A solid push higher in the first half followed by all sorts of potential trouble after.
Well the first half has been OK, so should we believe their view on the second half of the trading year?
The BoAML team think the S&P 500 would get to 2,863 and then head south. Rising bond yields, and the fact that stocks have outperformed bonds for seven years — ominously the longest streak since 1929, is worrying the BoAML team.
There are a lot of ‘ifs’ and ‘buts’ in this analysis but one that’s easy to watch is wages.
“The game changer is wage inflation, which on our forecasts is likely to become more visible,” said Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, who projects that salaries could rise 3.5%, and push the consumer price index up 2.5%, and convince the Fed that it’s close to meeting its 2% inflation goal.
Interestingly, BoAML has been bearish for some time. In February, Tyler Durden on marketwatch.com revealed the following: “Exactly one month ago, just as the S&P hit an all time high, Bank of America caused a stir when it announced that one of its proprietary “guaranteed bear market” indicators created by the Bank of America quants was just triggered,” he wrote. “As we said at the time, what was remarkable about this particular indicator is that it predicted not only the size of the upcoming drop (-12% on average) but also the timing (over the coming three months). Also notable: its uncanny accuracy: it was correct on 11 out of 11 previous occasions after it was triggered!”
This near ‘Papal infallibility’ of BoAML’s bear-spotting model has never come across my desk before but it sounds too good to be true.
So who do we believe?
April and May have been good for US stocks but they usually are.
Bloomberg’s year-end forecasts found that 24 strategists surveyed are expecting a 10% S&P 500 gain from current levels by the end of 2018.
Given we should be helped by a lower dollar, a strong global economy, an improving local economy and the outlook for commodities, if you can believe the RBA and Treasury, then our stocks should at least improve by 10%. That would take us to 6700, and so 7000 might be achievable, provided Donald doesn’t reignite trade war tensions and Italy does not try a Grexit-style Itexit, which could rattle financial markets.
My faith in Citi’s view, over the BoAML’s, is reinforced by my economic outlook for global, US and the Oz economies but can an economy be influential on stocks?
Earlier this year, when the US market dropped into a 10% correction, economists were arguing that a bear market isn’t coming because the economic readings are just too good.
“We just don’t see a bear market starting with the economy as strong as it is,” said Ryan Detrick, senior market strategist at LPL Financial in Charlotte, North Carolina. “You rarely see bear markets during a non-recessionary environment.”(Reuters)
Interestingly, Goldman Sachs found 11 pullbacks of at least 10% since 1976 that did not occur around a recession. Only one of those, in 1987, turned into a bear market. So bear markets and recessions make sense while bear markets with great economic showings and outlooks are less usual.
“You never know, but just the fact that earnings are expanding as strong as they are, (indicates) in our opinion very little chance of a recession over the next 12 months,” Detrick said.
S&P 500 profits are expected to grow at 18.8% in 2018, a bigger increase than the 12% projected at the start of the year, according to Thomson Reuters I/B/E/S. And the recent annual 12-month rise was a huge 26%, which should push the calendar year growth above 18.8%!
I’m not sure if we will see 7000 on the S&P/ASX 200 Index this year. A lot of things have to go right and Donald Trump and the Royal Commission have to hold back on their curve balls. But if Citi and the economists are right, we could pocket a nice 15% gain before dividends. This makes an ETF for our top 200 companies an interesting play.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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