Nothing goes up forever, and US stocks have been on an historic run since 2008. A new report from Credit Suisse Global Equity Research says the U.S. stock market run is at least going to slow to a crawl next year, and may even fall for the first time in eight years.
In the introduction to the December 2nd report, CS analyst Andrew Garthwaite and team discuss their expectations for equity markets over the next 12 months: “We reduce our weighting in equities to a small overweight, our most bearish strategic stance on the asset class in seven years (we previously had tactical downgrades in January 2013 and June 2011). Consequently, we reduce our mid-2016 target for the S&P 500 to 2,150 (from 2,200), and introduce a 2016 year-end target of 2,150. Outside the US, we are more constructive on equities.”
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Five reasons to not expect much from US stocks
- Valuations of US stocks are currently approaching fair value. Garthwaite et al. note that U.S. equities are now trading close to their fair value on two preferred valuation models for the first time in five years. Of note, the equity risk premium is 5.4%, which is close to the warranted ERP (based on credit spreads and ISM). The CS fair value P/E model for the S&P 500 offers a multiple of 16.9x relative to 16.6x now, a mere 2% upside.
- Equities are facing increasing global macroeconomic headwinds. The CS team says the two key headwinds for 2016 are: “i) China’s economic growth has never slowed to such a degree when it has been such a major component of the global economy (with China having been responsible for c.40% of global GDP growth over the past five years); ii) The Fed is set to increase interest rates for the first time in 9.5 years.” They note that equities has averaged a 7% decline after the first Fed rate hike, but the first rate hike has not marked the end of a bull market, with equities up 2.2% on average in the six months following the first rate hike. The analysts argue the “risk on this occasion is that the first rate hike has not occurred this late into the profit margin cycle.”
- The CS analysts also point to earnings momentum, credit spreads and buybacks as troubling signs. They note that earnings momentum is approaching a 4 year low with U.S. firm margins apparently peaking. Credit spreads have already increased by more and for a longer period than they have before bear markets (and almost to the levels seen before a recession), and buyback as a style is now underperforming, undermining what an important source of equity demand. Credit Suisse HOLT® analysis suggests that buybacks represent 27% of EPS growth over the last three years. Moreover, M&A is at the bottom end of the range at which it and equities peak, though M&A typically lags stocks by six months or so. Garthwaite et al. also express concern about the fact that near-record corporate buying has not boosted US stocks over the last 12 months.
- It is also clear that a shift from capital to labor is taking place. Wage growth is accelerating (especially in the U.S. and the UK), and the profit share of GDP is now finally begin to slip. This shift is abetted by government trends toward increasing the minimum wages, particularly in the UK, U.S. and Japan. Other government initiatives such as efforts to close corporate tax loopholes threaten corporate profits..
- New business models are disrupting the old economic system. Garthwaite and colleagues point to the growing number of sectors have face threats from disruption, regulation or emerging markets. Finally, the analysts argue that the competitive threat posed by Chinese firms is generally under-estimated as government-supported industries in the Middle Kingdom continue to over-invest, slashing the gap between the RoE and the cost of debt, and moving up the valued added curve.