Buy High, Sell Higher - Wells Fargo Advisors
WEEKLY PERSPECTIVE ON CURRENT MARKET SENTIMENT
Buy High, Sell Higher
November 1, 2017
Scott Wren Senior Global Equity Strategist
Key Takeaways
Last Week’s S&P 500 Index: +0.2%
» There appears to be some “chasing” occurring in the stock market right now as institutional investors try to keep pace with their equity benchmarks.
» Equity valuations, in our opinion, look high relative to the fundamentals we expect to play out over the next 14 months.
Is the S&P 500 trading higher than this strategist thinks it should be? If you are a regular reader of this weekly piece, you already know the answer. In short, equity valuations look stretched at current levels given our fundamental outlook. Could tax cuts/reforms change that fundamental outlook? Yes, that is possible. We do expect something to get passed by Congress and eventually be implemented, but the big question is whether it will be enough to change our fundamental outlook and possibly our year-end domestic equity-index targets. After all, the campaign season for the midterm elections is just around the corner. Those running for re-election might want to tout tax cuts in their campaigns as an example of “bringing home the bacon” to their constituents. But just remember, we are living in an $18-plus trillion economy. To move the needle, any kind of “stimulus” has to be big to be meaningful. Small just isn’t going to do it. So now, for a minute, let’s get back to reality and what we do know, or at least think we know. Stocks, based on our analysis, are trading well above their historical median levels based on various valuation criteria. For instance, consider the price-to-earnings, or P/E, ratio for the S&P 500 Index. Looking back over the last 30 years, the median level based on rolling four-quarter periods is 16.7x (times) trailing 12-month earnings. As of the time of this writing, the S&P 500 is trading at 20.4x trailing 12-month earnings—an attention-grabbing premium in our opinion. Granted, one could argue that the low levels of interest rates and inflation should warrant a higher P/E ratio, but the market is far from convinced that these low rates are going to ignite economic growth in a substantial way any time soon. Low rates certainly haven’t led to anything more than very moderate growth for the entire length of this recovery. Why would now be any different? In addition, note that another valuation metric, the price-to-sales ratio, is basically at a record high for the S&P 500. Of course, our analysis could be wrong. That happens from time to time in the working world of an equity strategist. In this business, it is just a fact of life; you are not going to be right 100 percent of the time. For instance, our earnings estimates for this year and 2018 could be too low. Domestic companies might surprise us with their ability to generate profits in this modest-growth economy. That certainly is what happened in the first half of this year. Or the Federal Reserve (Fed) may choose to move interest rates higher at a much slower pace than we currently anticipate, thus lending some truth to the expression “don’t fight the Fed.” Stocks usually like it when our central bankers stick with easy, or easier-than-anticipated, monetary policies. Then again, the exuberance of investors, especially institutional investors and asset managers, might move higher more quickly than we expect. This is usually a late-cycle phenomenon where equity indices used as benchmarks keep moving higher despite valuation concerns. These investors find themselves “paying up” for stocks so they can try and keep pace with the benchmarks they are judged against. They hope to buy high and sell higher. Sound familiar? © 2017 Wells Fargo Investment Institute. All rights reserved.
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Risks Considerations Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. These risks are heightened in emerging markets.
General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR 1017-05633
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 2 of 2
Buy High, Sell Higher
November 1, 2017
Scott Wren Senior Global Equity Strategist
Key Takeaways
Last Week’s S&P 500 Index: +0.2%
» There appears to be some “chasing” occurring in the stock market right now as institutional investors try to keep pace with their equity benchmarks.
» Equity valuations, in our opinion, look high relative to the fundamentals we expect to play out over the next 14 months.
Is the S&P 500 trading higher than this strategist thinks it should be? If you are a regular reader of this weekly piece, you already know the answer. In short, equity valuations look stretched at current levels given our fundamental outlook. Could tax cuts/reforms change that fundamental outlook? Yes, that is possible. We do expect something to get passed by Congress and eventually be implemented, but the big question is whether it will be enough to change our fundamental outlook and possibly our year-end domestic equity-index targets. After all, the campaign season for the midterm elections is just around the corner. Those running for re-election might want to tout tax cuts in their campaigns as an example of “bringing home the bacon” to their constituents. But just remember, we are living in an $18-plus trillion economy. To move the needle, any kind of “stimulus” has to be big to be meaningful. Small just isn’t going to do it. So now, for a minute, let’s get back to reality and what we do know, or at least think we know. Stocks, based on our analysis, are trading well above their historical median levels based on various valuation criteria. For instance, consider the price-to-earnings, or P/E, ratio for the S&P 500 Index. Looking back over the last 30 years, the median level based on rolling four-quarter periods is 16.7x (times) trailing 12-month earnings. As of the time of this writing, the S&P 500 is trading at 20.4x trailing 12-month earnings—an attention-grabbing premium in our opinion. Granted, one could argue that the low levels of interest rates and inflation should warrant a higher P/E ratio, but the market is far from convinced that these low rates are going to ignite economic growth in a substantial way any time soon. Low rates certainly haven’t led to anything more than very moderate growth for the entire length of this recovery. Why would now be any different? In addition, note that another valuation metric, the price-to-sales ratio, is basically at a record high for the S&P 500. Of course, our analysis could be wrong. That happens from time to time in the working world of an equity strategist. In this business, it is just a fact of life; you are not going to be right 100 percent of the time. For instance, our earnings estimates for this year and 2018 could be too low. Domestic companies might surprise us with their ability to generate profits in this modest-growth economy. That certainly is what happened in the first half of this year. Or the Federal Reserve (Fed) may choose to move interest rates higher at a much slower pace than we currently anticipate, thus lending some truth to the expression “don’t fight the Fed.” Stocks usually like it when our central bankers stick with easy, or easier-than-anticipated, monetary policies. Then again, the exuberance of investors, especially institutional investors and asset managers, might move higher more quickly than we expect. This is usually a late-cycle phenomenon where equity indices used as benchmarks keep moving higher despite valuation concerns. These investors find themselves “paying up” for stocks so they can try and keep pace with the benchmarks they are judged against. They hope to buy high and sell higher. Sound familiar? © 2017 Wells Fargo Investment Institute. All rights reserved.
Page 1 of 2
Risks Considerations Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. These risks are heightened in emerging markets.
General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR 1017-05633
© 2017 Wells Fargo Investment Institute. All rights reserved.
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