All the Stuff Bears Are Saying to Spoil the S&P 500 Record Party
(Bloomberg) -- Stocks are back, the ordeal is over, order has been restored. But as you puff on your S&P 500 victory cigar, pour out a drink for the bears, who just four months ago had everyone convinced they were right.
Or lend an ear, at least, because the Dow Jones Industrial Average’s 10,000-point round trip has done little to shut them up. Here are all the things they say will launch stocks back into free fall after the best start to a year since...1987.
“There’s more bearish arguments this time around than you usually see,” Matt Maley, equity strategist at Miller Tabak + Co., said in an interview. “Forget about the China trade war. People have almost forgotten about that. And Brexit -- nobody’s even talking about that, the last two weeks. But we do have concerns.”
If profits drive stocks, the terrain ahead is uncertain. Sure, analysts say the first quarter will mark a trough in S&P 500 earnings, and everything is supposed to be fine by September. But to believe that, you must lay aside the history books.
Corporate income is expected to jump 8.7 percent in the last three months of 2019, bringing profit growth for the full year into positive territory. But Wall Street has a near-perfect record of over-estimating earnings, and those forecasts are almost sure to come down. Full-year earnings estimates normally drop by about half a percentage point each month, according to QMA. If that happens, kiss the fourth-quarter recovery goodbye.
Built into the S&P 500’s recovery is the assumption the Federal Reserve is on hold for the year after rough markets in 2018, questionable economic data, and geopolitical risks forced the central bank to pivot. But what if the supposition is wrong?
Four months after the bull market nearly went kaput, shares are back at record highs. Economic data has been rebounding, too, with strong retail sales in the U.S. providing the latest dose of confidence. And while inflation remains subdued, nobody’s sure how long that will last with oil prices surging to six-month highs.
Add it all up, and bears will tell you a Fed rate hike could still be on the table. The central bank changed its mind once this year. Why can’t it do it again?
“A re-pivot by Powell so quickly would increase implied vol, erode Fed credibility, and lead the yield curve to invert,” Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, wrote in an email. “None of these outcomes are desirable.”
Investors are ultra-sensitive to whether China will maintain the massive scale of stimulus seen in the first quarter, and officials are signaling that they might be stepping back.
A Politiburo statement late last week was interpreted by traders as meaning that the economy is on strong enough footing that increased support might not be needed. Instead, there’s a focus on deleveraging. China’s central bank cut some of the long-term funding it supplies to banks. Stocks have taken a breather following the news, with the CSI 300 Index of equities traded in Shanghai and Shenzhen falling about 3 percent since Friday.
“A lot of people are assuming that the turnaround in China will help the global economy bounce back in a big way,” said Maley. “It sounds like they’ll be a little less stimulative. Therefore, we might not get the bounce-back that people are looking for.”
Cash Versus Stock Deals
One bearish thesis holds that companies themselves consider their own shares richly valued. The evidence: a propensity among corporate buyers to use stock, rather than cash, to fund takeovers. While smaller deals have been quiet, mergers and acquisitions valued at more than $10 billion have been alive and well. And 70 percent of deals of that magnitude have been funded with stock. While far from definitive evidence, when companies are this willing to part with their equity, maybe you should be, too.
Valuations may be more reasonable now than they were back in September, particularly because rates have fallen, but a case can be made that stocks are looking more expensive by the day when eyeing 12-month forward price-earnings ratios. Notably, technology firms are trading at the highest multiples since 2007.
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