The bull case: Part II

RYAN  By Guest Blogger Ryan Lewenza

In my last post I examined the bear case for the equity markets. I cited high valuations, age of current bull market, and the inevitable end of accommodative central bank policies. This provoked a sense of validation or “I told you so” sentiment from some of the bearish blog dog readers. Well buckle up you doomers and believers in the coming zombie apocalypse, as I’m going to present our bull case for further equity gains in 2017. I can already envision the Darth Vadar (or Kylo Ren for you youngsters) rage I’m likely to encounter in the comments section of this pathetic blog (Garth’s words). There goes my Saturday!

In developing my market outlook I always start with the economy. As Bill Clinton’s campaign strategist James Carville famously said “It’s the economy, stupid!” I see the US and global economy picking up this year. I’m expecting the US economy to grow around 2.5% this year, up from a lackluster 1.6% in 2016. I see the consumer continuing to do most of the heavy lifting, but see the potential for a boost from business investment and government spending if President Trump is able to pass some of his pro-growth policies.

Most of the economic data I track shows a clear acceleration in recent months. US Q3/16 GDP came in at 3.5% Q/Q annualized, which is the strongest quarterly growth rate in two years. The US economy did slow in the fourth quarter to 1.9%, but the trend in economic data remains clearly to the upside. This includes continued strength in the labour market, housing, auto sales, industrial production etc.

One economic indicator I track closely is the US Citigroup Economic Surprise Index, which measures how economic data is coming in relative to economist’s expectations. It’s recovered nicely in recent months (capturing data is coming in above expectations) and is at a level not seen since 2014.

Finally, I focus a lot on manufacturing data as the manufacturing sector is highly cyclical capturing the ebb and flow of the economy. I analyze manufacturing data across all the major countries and regions, and as illustrated below, manufacturing globally is in an upswing with the global manufacturing index at the highest level since February 2014.

In summary, I see the odds of a US recession as remote for this year (Bloomberg estimates it at 15%) and in fact, I see the US and global economy re-accelerating following a soft patch last year.

Global Manufacturing Is Rebounding

Source: Bloomberg, Turner Investments

A stronger economy should bode well for higher corporate profits this year, which is the main thrust of our bullish outlook for 2017. Stocks rise through either an increase in valuations (e.g., P/E rises from 10 to 12x), or through an increase in corporate profits. Much of the gains over the last few years have been by an increase in equity valuations. For example, the P/E ratio for the S&P 500 has increased from roughly 17x in 2014 to a lofty 21x currently. I believe the equity markets will transition from a valuation driven market to an earnings driven market this year. And the recent results are showing this.

The S&P 500 experienced an earnings recession in 2015 and first half of 2016, posting a number of consecutive quarters of Y/Y earnings decline. However, this trend reversed in Q3/16, with S&P 500 earnings hitting an “inflection point”. Based on Bloomberg data, Q3/16 earnings rose 2.3% Y/Y with the current quarter tracking at an impressive 8.6% Y/Y.

Given our expectations for stronger US and global growth, I see earnings continuing to improve this year, thus driving US and Canadian stock prices to new all-time highs. Currently, analysts are forecasting S&P 500 earnings to rise 19% to $130/share in 2017. I think this is overly optimistic and see earnings growing by high single digits, helping to realize my year-end price target of 2,400 for the S&P 500.

Critically, this forecast does not embed the potential for President Trump and Congress to lower the US corporate tax rate. The US corporate tax rate is currently 35%, and is one of the highest of any developed nation. President Trump is proposing to lower the corporate tax rate from 35% to just 15%, while House Republicans are pushing for a cut to 25%. Regardless of the final rate reduction, a cut to corporate tax rates of even 10% would equate to over $13/share in S&P 500 earnings according to Thomson Reuters. If this gets passed this would be huge for corporate America and could provide more fuel to the equity markets, possibly resulting in the S&P 500 surpassing my 2,400 price target for this year.

S&P 500 Earnings Are Rebounding

Source: Bloomberg, Turner Investments

Finally, I believe strongly in combining fundamentals with our technical readings of the markets in determining our outlook and strategy. And in my opinion the technicals are demonstrably bullish for the equity markets at present. Looking at the chart below you can see that the S&P 500 remains in well-defined long-term upward channel. Note the trend of “higher highs” and “higher lows” which is the definition of an uptrend.

Additionally, the S&P 500, and most other global equity markets are trading above their rising 200-day moving averages, which again defines an uptrend. And finally, market breadth, which measures the number of stocks advancing versus the number stocks declining, is very strong with the NYSE Advance/Decline line continuing to make new highs. This is very bullish and is confirmation of a healthy bull market.

I could go on and on, citing numerous charts and indicators that show a healthy bull market. But you have other things to do other than reading this pathetic blog on this Saturday. Suffice to say, given our positive assessment of the economic, fundamental and technical readings of the economy and stock market we’re sticking with our bullish outlook. As referenced in my last blog post, “when the facts change, I change my mind.” We’ll adjust accordingly when the weight of evidence tells us to do so. Until then, stay long and prosper!

The S&P 500 Is In A Long-term Uptrend

Source: Stockcharts, Turner Investments
Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.

Culture of envy

“Jeez,” says Jerry, “this has been a depressing week of blogs. Maybe you should do a series on ruptured hernias. Or an analysis of fungal infections. Would be an improvement, dude.”

I get it. But we can’t spend all day talking about goofy bidding wars or balanced portfolios. Sometimes what governments are doing, plus what we’re doing to ourselves, must be dragged into the sunshine and vivisected. As we head into the second T2 budget – the nasty one, two years before an election – a debate about where the country’s headed is just.

Is taxing our few (286,000) wealthy people at 54% okay? Should everybody with a mutual fund or a rental condo pay more in capital gains? Is Hoovering the dividend income of retired people overdue? Do we need a tax on house profits? Can a country become stronger, fairer, more prosperous by increasing the tax burden? Is more government the answer to income inequality?

Seems we hit a spot where the 99% hate the 1%. Where Millennials despise Boomers. Where the houseless blame immigrants. Workers hate bosses. The surprising pro-Brexit, pro-Trump sentiment here (now morphing into pro-O’Leary) shows many people want to elect and support disruptors, blow up the status quo and dismantle elites. When the POTUS can stand in a presser and call the reporters he summoned “fake news”, then speak proven falsehoods and is cheered on by his supporters, we’re clearly on a dangerous voyage.

Edelman Canada’s a marketing outfit that polls people so it can help companies sell stuff. The result is a Trust Barometer. And the latest one’s a shocker.

Faith in business, politicians or reporters is at low tide. Populism’s on the rise, fueled in no small way by the power of social media – allowing like-minded groups of people to find each other, bypass mainstream thought, and coalesce into armies. Brexit was won through YouTube. Trump triumphed with Twitter. CNN or the New York Times, meanwhile, have been trashed and marginalized. News is now what you agree with. What you don’t, is fake.

Edelman found 61% of Canadians have lost faith in leaders. Eighty per cent think elites are out of touch. Half believe immigrants are bad. A third feel free trade is wrong. Over half (55%) said they don’t listen to news they disagree with and are 3.5 times more likely to ignore facts supporting a position they don’t support.

Trump knows all this. He can claim to have received the most electoral support “since Ronald Reagan”, call Mexicans “rapists”, suggest Muslims are terrorists or claim there were three million illegal voters, and get away with it. In Canada our leaders know they can claim that by vacuuming a relative handful of rich everyone else will get more. It’s what people wish to think. It’s popular. So it’s fact.

As society drifts to the extremes, middle ground is being lost. No shock that “progressive conservatives” no longer exist, replaced by hard-right Cons and increasingly leftist Libs. In the US election three months ago public sentiment was split right down the middle. In Canada we have a majority government elected by a minority of voters. Common ground is uncommon. It’s as if there’s no longer any unity of purpose. About anything.

“Garth, I do not comment openly on blog sites for the sake of privacy but the observations you have been sharing recently are too important to let pass,” says a blog dog from the West. “My wife and I are among the 1% that you often reference.  For many years we have worked hard, taken risks, reinvested after-tax earnings, produced valued products, and employed many.  We have paid substantial taxes during the past decades at levels we had already considered punitive.  With the changes in tax policies at the provincial and federal level during the past two years, the incentive to reinvest has been lost.

“Canada has become a country where the fruits of our labor and investment are no longer respected.  Every action our political leaders now take, plays to an outcome that is increasingly more hostile to the values we wish to instill in our children.  I am now spending most of my time considering how to transition our business to a country where they understand the need to allow the market to reward hard work, innovation, and investment.  I would like to be allocating my focus to our production in Canada however these days it feels far less like home.  My children will not find the change easy because they don’t fully understand the relationship between incentive and risk.  If I am successful my grandchildren may thank me.

“Of all the trends you have identified Garth, the practice of envy politics through taxation policy may be the most harmful to this country.  Housing bubbles correct with great regularity, but the creation of a culture of envy will be difficult to overcome.  If the Canadian housing bubble has shown us one thing it is that momentum is not easily changed once it has taken hold of the people.”

Well, this blog won’t change anything. The die is cast.

On Sunday. What to do as the revolution comes.