Catalyst Needed?

by Scott Wren, Senior Global Equity Strategist

Key takeaways

  • We believe the S&P 500 Index is at or near “fair value” for this point in time given the numerous risks to the earnings and economic outlook.
  • A catalyst is needed, in our opinion, to push stocks meaningfully higher than current levels.

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Another week, another attempt by the S&P 500 Index to push through a meaningful technical resistance level. This is becoming a pattern as stocks have climbed and wrestled with one resistance level after another over the course of the past 8 to 10 weeks. First, it was breaking through and holding above a downward-sloping trend line in late January. Then came the frequently important 200-day moving average in the middle of February. And finally, last week, the index broke through and closed above resistance in the 2,810–2,820 area that could be traced back to the early October 2018 high. It took five or six tries, but in Friday’s big volume session when futures contracts and options on futures and stocks expired, the S&P 500 Index closed just above this much-ballyhooed psychological level.

But is this grinding rally going to hold up? Are we on the verge of seeing equities move up closer to and test their late September/early October highs? In recent weeks, we have been writing about our belief that some sort of consolidation phase was likely going to take place. After all, from the Christmas Eve low, the S&P 500 Index has jumped slightly more than 20% without taking much of a breather along the way. On a year-to-date basis, the index is up nearly 13%. That is well over an average year’s worth of gain in less than three months. That doesn’t happen very often. It would be reasonable to expect some sort of giveback.

Our regular readers know there are multiple risks on our radar screen right now that could negatively affect the stock market if the outcome was not to investors’ liking. Probably the biggest immediate risk is the outcome of the U.S.-China trade negotiations. That plays into the overall risk of slowing global growth this year versus last year. Gross domestic product estimates have come down in most of the major economies and regions around the world (including the U.S.). When 35% to 40% of revenues for the S&P 500 Index come from outside the country, we need help from these international economies to hit our earnings targets. And earnings uncertainty has risen as economic growth expectations have deteriorated.

Our current analysis calls for earnings growth near 7%. Street consensus is calling for growth this year to be close to 4%. Looking on a sector basis, we believe expectations are too low for our favored Information Technology sector. In addition, the consensus is looking for a big slump in Energy sector earnings, but our analysis suggests we will likely see Street estimates rise in coming months as crude oil tests the $60 per barrel level. Note that our commodity analysts’ 2019 year-end target range for WTI (West Texas Intermediate) oil is $60 to $70. The midpoint of this range would represent an approximate 10% increase for oil from current levels and, in our opinion, would lead to an increase in consensus earnings estimates for the Energy sector.

The stock market is assuming there will be some degree of positive news coming out of the current trade negotiations between the U.S. and China. We agree but think these positives are likely to be more of an intermediate-term story. We continue to believe that the S&P 500 Index is at or near fair value and that a catalyst is needed to push stocks meaningfully higher than current levels.