Earlier this year, some were questioning whether the S&P 500 Index would ever hit 2000 again, and now it continues to bounce around. The benchmark closed right around 2000 on Monday but began moving lower early this morning. It seems any reassurance economists have for investors and even the recent positive data points are not enough to hold the S&P 500 Index above 2000.
Economic growth still slow
In a report dated March 7, Deutsche Bank strategists David Bianco and Winnie Nip note in a report titled “Remember that February feeling?” that economic growth has been slow for the last four years and still is. Macro data has been mixed, and the debate about when we can expect the U.S. Federal Reserve to hike rates again continues.
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Sales and earnings among companies in the S&P 500 Index excluding Energy remains slow, and they said the index including Energy is in its fourth profit recession in more than 50 years.
They add that although profit recessions result in earnings declines that are much smaller than those caused by broader economic recessions at about 2% compared to 20% for a full-on economic recession, there are reasons to still be concerned, at least until the drivers of the profit recession wane. As a result, they’ve changed their next 5% increase in the S&P from Up to Balanced Risk with the main issue being stability in the U.S. dollar, especially around this month’s meeting of the European central bank.
S&P 500 Index – Still bearish on Energy
Even though oil prices rallied a bit last week, the Deutsche Bank team remains bearish on Energy. Excluding the sector, however, they’re bullish on the S&P 500 Index, which was trading at around 15.7 times their $118 earnings per share estimate when it was above 2000 on Monday. However, they’re assuming that the U.S. Dollar Index averages about 100 this year and that the euro doesn’t drop below $1.05.
They add that currencies are the big question mark and risk to earnings per share for the S&P 500 Index, excluding Energy. However, they expect the currency volatility to start to fade, falling off from what we’ve seen over the last year and a half because they think currency devaluations no longer stimulate their respective economies.
U.S. dollar’s strength may not be over
They do still see an elevated risk that the U.S. dollar will gain though based on the upcoming meeting of the European central bank and “reemerging potential” that the Fed will hike interest rates in June based on the solid job numbers we’ve seen so far this year. On the other hand, though they believe the risk “can be contained to slow and small further dollar gains,” but only if the Fed says it plans to spread its rate hikes out by four to six months and keep them at a neutral rate lower than history.
They see this as being reasonable because the risk of inflation in the near term is still “very low.”
Banks to benefit from Fed rate hikes
Of course Fed rate hikes would be a good thing for Banks, and they’re not at risk because of the U.S. dollar’s strength, and as a result, they are Deutsche Bank’s favorite high beta and value play, beating Energy, Materials and Industrial Capital Goods. In addition to Banks, they also like Airlines and see some value in some cyclical Consumer Discretionary stocks, which they think can move higher even though the broader sector is probably range-bound for now.
They don’t believe oil prices will move higher than what they have recently and in fact expect them to disappoint against the $65 per barrel average for next year that’s built into the current valuation of the Energy sector. They think the Technology sector is now more fairly valued because of the recent rally, the currency headwinds, and the very slow corporate spending trends.
Health Care: upside with low macro risk
The Deutsche Bank team sees Health Care as potentially offering the greatest opportunity for upside with the lowest macro risk. They note that the PE on Consumer Staples Product has climbed to about 21, carried by the “persistently low” interest rates. The low rates have also carried regulated Utilities to a PE of about 17, although large-cap Pharmaceuticals and Biotech stocks are at a PE of about 15 times earnings per share estimates for this year.
Further, they believe both near and long-term earnings per share growth from both Pharmaceuticals and Biotech firms to be stronger than that of other non-cyclical industries and the S&P 500 Index.