The S&P 500 is due for a selloff but with “little or nothing priced in for prospective policy changes” there’s room for further according to a new research report from analysts at Deutsche Bank. According to an asset allocation research note written by Chief Strategist Binky Chadha, the current S&P 500 rally has gone 10 months without a 3% selloff, making it the 3rd longest since WW II. Typically, 3% to 5% selloffs occur every two to three months, making the current rally an outlier. The only times an equity rally ran longer without a 3% + selloff was in 1993 (11 months) and 1995 (1 year).

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Prospective Policy Changes Not Priced Into S&P 500

However, even though the market is due a selloff based on past trends, Binky Chadha believes that "at the current juncture, we see little or nothing priced in for prospective policy changes so there should be little disappointment on lack of policy action." This effectively rules out any politically inspired selloff, something other analysts have been calling for. Prospective Policy Changes Not Priced Into S&P 500

Prospective Policy Changes Not Priced Into S&P 500

The Deutsche Bank analyst believes that rally following the election was not driven by policy expectations, instead, it was "perfectly in line with typical post-close-election rallies." Moreover, "relative performance at the sector and stock levels was uncorrelated with the mooted policy changes." While this is good for the upside, it's not so good for the downside as while the market isn't pricing in any positive policy changes, it's also not prepared for any negative actions, such as "an escalation in trade friction."

Prospective Policy Changes Not Priced Into S&P 500

 

Aside from policy changes, Deutsche Bank sees a relatively positive environment for equities. In particular, the bank notes that companies are growing earnings strongly with Wall Street projections pointing to earnings per share growth of 9.6% on average during Q3. Also, short interest has declined to lows not seen since 2007 and buybacks remain supportive. The one headwind US equities face is that since March there have actually been persistent outflows from US equities and cumulative flows YTD are now in fact slightly negative while there have been robust inflows to equities in the rest of the world. A return of inflows is key and would power the S&P 500 to the bank's year-end target of 2600:

"From a demand/supply perspective for US equities, buybacks should remain supportive albeit at a more moderate pace, while short interest has already fallen to the bottom of the range prevailing since the financial crisis leaving less room for a further decline near term, albeit still well above pre-crisis levels so can potentially decline medium term. So a return of inflows is key. The three factors which have prompted the puzzling outflows from US equities are all in our view set to turn: (i) data surprises have already started to turn up from the bottom of their historical band; (ii) rates are poised to go higher as inflation picks up from a lagged response to growth amidst upside from a tightening labor market and a lifting dollar drag; (iii) prospective moves in rate differentials and short positioning argue for the dollar to move up from the bottom of its 2½ year range."

Prospective Policy Changes Not Priced Into S&P 500