Uncertainty on several fronts—Federal Reserve policy, trade wars, and economic growth, to name a few—brought the S&P 500 (.SPX) to the brink of a bear market in late 2018. But as those overhangs have begun to be resolved largely in investors’ favor, there’s room for stocks to trade at higher valuations, according to Jonathan Golub, chief U.S. equity strategist at Credit Suisse.
“We’re not seeing stronger growth, but we are seeing a reduction in risk,” says Golub, who has a 3025 year-end target for the S&P 500. “And while everybody wants to see a powerful economy, that’s just not what’s fueling this thing.”
The backdrop is much more benign today than it was six months ago. Market pricing implies a greater chance of an interest rate decrease by the Fed in 2019 than an increase. While a final resolution isn’t yet signed, the U.S.-China trade dispute has come a long way from successive rounds of tariffs and counter-tariffs by the world’s two largest economies. As during market’s slow and steady upward rise in most of 2018, stock volatility has again declined to below-average levels. And finally, while recent economic data has softened slightly from 2018’s blistering pace of growth, it’s still far from recessionary. In fact, says Golub, the deceleration is a positive because it means the economy has avoided overheating and causing more severe inflation.
While year-over-year comparisons showing weaker job gains or leading indicators suggesting decelerating economic growth may continue to draw headlines, Golub sees investors coming to appreciate the more agreeable backdrop and paying a higher multiple on the same level of earnings.
“Equity investors can have a hard time with that because what they tend to think is ‘markets go up when news is good, and go down when it’s bad,’ Golub says. “They don’t tend to think the market can go up when the outlook is maybe not so rosy, but the backdrop is much less risk prone. But maybe that’s great.”
It’s the kind of “Goldilocks scenario” that Golub can see continuing for some time. While the current post-financial crisis economic expansion is one of the longest ever in the U.S., the average rate of growth has been much slower than in previous cycles. It’s a sign of a tamer environment with less volatility that should also result in shallower recessions more spread out from one another.
As the U.S. economy continues to become more services-intensive and businesses’ capital requirements decrease, the market may keep interests rates low regardless of central bank actions. Discount rates and risk premiums should both be structurally lower in such an environment. “If that’s the case, in coming years you could have an upward drift in stock multiples even though the earnings growth may be more contained,” says Golub.
And who knows how long that might last?
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