Days after the S&P 500 broke out of a historically unusual tight trading range for the past three months, Deutsche Bank is predicting a surprise move up for the index.
“We see a broader-based more sustainable move up in the S&P 500 on an imminent turn-up in growth and a positive data surprise phase,” the German bank’s global research team said in a newsletter last week. “Our 1-month surprise index (MAPI) leads and is pointing to a turn up in the 3-month CESI,” it added.
The MAPI uses only the last 30 data releases, weighing each equally. In contrast, the Citigroup Economic Surprise Index uses three-month data. Discarding two months of data – including negative macro data surprises – from the CESI apparently leads to the optimism.
Also, CESI is near the bottom of the range from where it has typically turned up, with exceptions being recessions and other large shocks. In the present data surprise cycle, the CESI has fallen from a high of +58 in mid-March to a low of -39 last week, traversing nearly all the negative data surprise cycle, the bank said.
Deutsche Bank points to four underlying factors for a bump up in the S&P 500. They are:
Payback for seasonally poor Q1. Up to one percentage point may have been depressed in the first quarter on account of “lingering issues with seasonal adjustment.” This adjustment will be redistributed in later quarters in the year, with Q2 and Q3 the primary beneficiaries. Deutsche Bank estimates 3.3% GDP growth in Q2.
Rising consumer spending. On account of a “variety of idiosyncratic factors, including a weather-related decline in utilities spending in Q1 and the timing of holidays,” real personal consumption expenditure registered its weakest quarter of growth since 2009. The bank expects a move back to 3%+ growth, a rate seen since early 2014.
Rebound in capex and rise of labor market. Both capex and the labor market always lag recoveries in growth and a slowdown in each is strongly correlated with the rise in the dollar and collapse in oil prices. Consequently, the recovery in capex over the last three quarters and its level suggest “significant further upside.” The labor market responds with even longer lags of six quarters and “we see total hours at the cusp of beginning to grow at above trend rates for a sustained period.”
Synchronized pick-up in global growth. The bank’s diffusion index of global synchronization, the share of countries with PMIs above 50, is at a six-year high and still pointing to continued upside. It sees positive cross-country spillovers on account of the synchronization with breadth adding to the magnitude and duration of the ongoing pickup.
On asset allocation, Deutsche Bank remained overweight on equities and underweight bonds. It also maintained sector allocation short rates (overweight financials, underweight staples and utilities); overweight industrials, discretionary and tech; neutral on healthcare, energy and telecoms; and underweight on materials.
“The missing link for equities remains rates, with the 10y yield like equities having been in a range, but unlike equities closer to the bottom of its range. But with a Fed increasingly communicating a willingness to hike and begin normalizing its balance sheet but the term premium in rates negative, speculative positioning in bond futures long, and abnormally strong inflows into bonds ytd heading into a seasonally weak period, in our view this is not a matter of if but of when.”
