We’re often invited by CNBC or Fox Business to offer our stock market outlook and/or investment insights. We typically don’t find it helpful to comment on the “hot” stock of the day, or offer answers on what daily volatility “means” for investors. We simply present our views on longer-term trends, as well as input on where we’re allocating client dollars. With this in mind, below is an update on our current thinking:
The sell-off since the most recent highs on May 22 has been driven by two key factors:
- A reversal in the perception that the Fed would be accommodative for at least the next two years. This has resulted in a spike in long-term interest rates and a rise in the forward curve for the Fed funds rate. Markets are basically pricing in a “lift-off” of Fed funds a year sooner than they were in late May. This has led to a decline in the equity premium. Stocks are viewed as less attractive as interest rates have risen from the policy-driven lows.
- A perception that the new (as of last September) Chinese economic regime is determined to reign in credit growth, evidenced by the spike in interbank lending rates in late June. Concerns exist that this change could lead to further diminution in GDP growth in China and reduced demand for raw materials, marking the end of the secular bull cycle in commodities, which began early in the last decade.
Corporate earnings, as measured by the S&P 500, have come in about as expected year to date. Current consensus for 2013 is approximately $108, which we think is about 2 percent to 3 percent too high, as revenue growth remains weak. Our target for the S&P at year end 2013 is 1550, about 4 percent below current levels.
Key indicators we’re watching to determine if fundamentals are improving enough to justify a higher earnings and price target for the S&P 500 include bank lending, home prices and corporate capital spending. Bank lending is steadily improving, but in aggregate remains below pre-Lehman levels.
We’re also closely watching housing prices and new home starts after the spike in mortgage rates. We would expect the housing recovery to cool meaningfully if 30-year mortgage rates remain above 4.5 percent for more than a few months. We also expect corporate capital spending to provide an additional boost to production and GDP in the second half of 2013, as spending in recent years has been well below replacement levels.