Should investors continue chasing equities in the extended market rally? These brokerages weigh in.
Who's Talking: Tobias Levkovich, Chief Equity Strategist, Citigroup Global Markets
The Gist: Stock prices may go higher in 2010, but some of next year's upside may already be priced into 2009.
Levkovich has considered the momentum of the market’s rally to be "too much, too fast" and "fierce and unrelenting." Looking to the first half of next year, Nevertheless, Levkovich says his earnings analysis "supports a fairly strong start" led by rising industrial activity, improved credit conditions and "way too aggressive inventory de-stocking in 2009." There could be an early January selloff if investors choose to lock in 2009 gains, he says, but he would consider this to be a buying opportunity. Earnings have been the most critical factor in determining where the equity market is headed, and, in Levkovich's view, equity markets could go to 1,200 or higher in 2010. However, Levkovich says his team is "concerned that part of 2010's upside has been pulled forward into 2009 as investors have simply wanted more."
The outlook for 2010 is tricky, says Levkovich, because the Federal Reserve could decide to raise short-term interest rates next year, which may lead to higher bond yields and, in turn, the contraction of P/E multiples, even in the face of strong earnings growth. Levkovich says history suggests that during the first full year after the end of a recession, the S&P 500 index often moves less than the improvement in earnings. That means that the estimated 16% jump in 2010 profits, compared to projected 2009 earnings, may not be fully reflected in stock price increases next year, and his team "suspects that investors may not necessarily have thought through this concept." Of course, says Levkovich, the Fed may be unable to lift rates next year because of high unemployment or political pressure in Washington. Taxes will also go up in 2011 and midterm elections are likely to be "highly contested," he says, which means investors will most likely see their market gains in the first half of 2010.
Who's Talking: Liz Ann Sonders, Chief Investment Strategist, Charles Schwab
The Gist: The rally has gone on, but with earnings strength about to improve, the market still has legs.
Third-quarter earnings well exceeded expectations, says Sonders, but there is still "limited celebration and instead concern about cost-cutting's contribution." During the first quarter of 2009, the S&P 500 index shot up nearly 10% during earnings season, and it jumped more than 15% during the second quarter's earnings season, Sonders says. But in the third quarter, it only rallied 2.8%. Meanwhile, third-quarter earnings exceeded expectations, on average, by almost 15%. However, the fact that companies overall beat earnings expectations by wide margins isn't necessarily as good as it sounds, says Sonders. Only 59% of companies actually beat top-line sales expectations. Although that represents the highest reading over the past five earnings seasons, she says, it doesn't stand up to the 70% to 80% range of companies beating revenue expectations during the last bull market. The question, then, is what will happen in the fourth quarter. Will companies get that revenue "beat rate" higher? If not, "the market could suffer more bouts of indigestion," says Sonders.
She says the market is "unquestionably at an important inflection point for earnings," where the market moves from weak earnings to much stronger earnings. But "be careful what you wish for," says Sonders. The market tends to anticipate the turn in earnings prospects in advance. Historically, when investors have reached consensus about improvement, "the market has already had its move." Sonders says her team doesn't think that's happened yet. All in all, the earnings story has been rather "yeah, but…," meaning that the market has considered earnings improvement to be good but only because of companies cutting costs, not expanding their businesses. Considering that earnings strength is on the mend, Sonders says her team maintains that "the economic, earnings and market momentum all still have legs."
From the Brokers: Links to Broker Sites and Research Ameriprise Financial Barclays Charles Schwab DWS (Deutsche Bank) Edward Jones Fidelity J.P. Morgan Merrill Lynch Morgan Stanley Raymond James T. Rowe Price Wachovia Securities
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