Stocks have been strong three out of the last four days (including the Friday rally), but despite the impressive price action the fundamentals, as we see them, remain largely unchanged: 2,100 will remain a general valuation ceiling on the S&P 500, and given macro headwinds looming this summer adding to stocks here is unattractive from a risk/reward standpoint.
Now, I don’t want to come off like a perma-bear, or that I’m pooh-poohing every rally in stocks. So, I wanted to list four things that I’m looking for to turn my outlook positive on stocks.
1. 2017 EPS Solidify at $130/share. Right now, the bulls’ biggest argument (other than negative sentiment) is that on a 2017 valuation, the S&P 500 is trading at a reasonable 16X. That’s true, if $130 holds (remember $130 was supposed to be 2016 EPS, and we’re barely above $120 now). The problem is that while rising oil will help, revenue trends and margins remain under pressure, and a better-than-feared earnings season is not a “good” earnings season. Until revenue trends for companies improve, I’ll remain skeptical as to whether $130 will hold for 2017.
2. Fed Clarity. I’m not just talking about June, but beyond that the market needs to know what the Fed is looking at to decide policy. One month they’re dovish because of international events, the next they are hawkish because they successfully caused the dollar to decline. Some consistency on the Fed’s so called “reaction function” (meaning how does data and geopolitics effect their policy decisions) is needed, because right now many people on Wall Street don’t think the Fed has a credible plan (myself included). Instead the Fed seems as though it’s largely just flying by the seat of its pants. In a central bank dominated global economy, that does not make me want to pile into stocks.
3. Political Clarity. Brexit is likely going to be a non-event (at least according to recent polls), but US politics are just heating up. And as the polls tighten between Trump and Clinton, we’re looking at a summer of drama and nastiness. Depending on how things go, the fate of the White House, Senate, House and Supreme Court all could be called into question, and that’s a lot of uncertainty looming for the late summer/ early fall.
4. Economic Data Finally Breaks Out. It will be very hard to convince me that stocks can mount a material rally above 2,100 in the S&P 500 without the US economy finally breaking out of years of slow growth (about 2% annual GDP). It seems like we’ve been one quarter away from so called “escape velocity” for two years now, but the economic cycle is long in the tooth, and fundamental indicators on the economy, including credit availability and Treasury spreads, are flashing caution. And then there’s the May data that has started with a “thud.” Bottom line, if economic data gets better, then we can have an uptick in revenues and Fed clarity (they’ll consistently raise rates), but that escape velocity of 3% GDP or higher continues to remain elusive in 2016.
That’s what I’m looking for to become more positive and advocate a balanced or aggressive stance on stocks. As soon as that’s all satisfied, I’m happy do my Cramer imitation and say I think we should “Buy, Buy, Buy.” Until then though, we remain cautious.