We remain positive on US equities.
Our stance remains that the US equity market is the best one in the world. Why? Because we think EPS expectations are reasonably achievable for the next two quarters, that the base case for the US is positive earnings growth, whereas it is a decline in any other region of the world, and when most people do asset allocation, they will find the US relatively attractive. On that score, if you think of the US equity market as having modest positive (not declining) EPS growth, a 2.3% net buyback, a dividend yield over 2%, plus over 70% of all equities in the world with $100 million or more in daily trading volume, you start finding it difficult not to allocate some meaningful capital to at the very least a high quality basket of US equities. Hence, our guess is that the price-to-earnings ratio of the S&P500 could continue to expand.
We have been breaking the market into three groups: defensives, growth, and “the unknown”, which is our phrase for energy and financials given that forecasting the oil price and 10-yield has been nearly impossible.
–Defensive: we prefer utilities to consumer staples.
–Growth: we are overweight healthcare and underweight technology and prefer biotechnology to software.
–Unknown: we are neutral on financials and energy. For financials, we are generally attracted to the valuation, and think it is interesting they have recently performed well without a back-up in the long-end of the yield curve, but our house view is for a 1% US 10-year by Q1 of 2017, balancing our optimism. For energy, the oil market is healing, but the fundamentals of the offshore group are poor and the valuations of the exposed E&Ps don’t seem attractive. Exposure to the best properties in Texas and Oklahoma seems prudent.
What is implied by today’s market price?
Putting it all together, we forecast 4% earnings growth per year from now through Q1 of 2018. We apply a 17x multiple, 12 months from now, on earnings 13-24 months from now. This yields a 12-month forward S&P500 price target of 2200.