Why Stocks Will Move Higher In 2016: Fundstrat

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The S&P 500 has had its worst start to the year since 1901, but there’s plenty of evidence to support a rally throughout the rest of the year according to Fundstrat’s Tom Lee.

In a research report issued to Fundstrat’s clients at the end of last week, Tom Lee presented ten charts to support this conclusion. The charts suggest that S&P 500 earnings will improve during 2016 and valuations will expand further, driving equity outperformance.

It is not a coincidence that S&P 500 price performance stalled in 2015 as earnings flattened. It’s clear that three major factors were to blame for this performance:

double-digit gains in US dollar (constant-currency basis, S&P 500 EPS is estimated to have grown 8% in 2015);
falling oil prices. (The Energy sector accounted for $13 or nearly 12% of the overall S&P 500 EPS of $113 for 2014. But in 2015 the Energy sector will detract $2 from S&P 500 EPS, meaning that Energy will have accounted for a $15 fall in the index’s EPS — more than offsetting any EPS gains in other sectors.) And;
Emerging Market demand.
Two of these three headwinds are already dying off. According to Goldman Sachs, Energy EPS are expected to stage a comeback this year with the bank’s analysts expecting Energy EPS to equal $3 in 2016 and $5 in 2017. Also, unless the US dollar makes a renewed surge of double-digits, Tom Lee believes currency headwinds will fade sharply as we move through the first half. Increasing US consumer confidence and the housing market are two other tailwinds that Tom Lee believes could drive S&P 500 EPS during 2016.

However, the above thesis is at risk if the high-yield market continues to destabilize, liquidity conditions worsen, and a deeper rout ensues.

Fundstrat: Ten charts

Fundstrat has put together ten charts to back up its argument for higher equity prices by year-end 2016 — below are just five of the most interesting.

The first of these charts argues the point that there is still a lot of pent-up demand for US housing. Housing starts, at 1.173 million per year, remain at recession levels and are below the long-term average of 1.45 million. Moreover, compared to population growth, housing starts are running at the lowest level in 50 years. Over the long-term the ratio of housing starts compared to the change in US population is 0.62, or 62 homes for every 100 increase in population but at the end of 2015, this ratio was 0.38. To return to the long-term average of 0.62 housing starts need to average 1.8 million per annum for the next ten years.

Chart number two looks at the dollar’s effect on EPS. The strong dollar was the biggest impact on EPS in 2015, subtracting $93B or $10 per S&P 500 share. The good news is that the dollar has flattened since Q3 2015, and due to the rapid gain in the value of the dollar during the first half of last year, the currency would have to gain materially from here to have the same drag on EPS that it did in 2015. The DXY index year-on-year change peaked at 20% during Q2 2015; it’s high unlikely that the index will repeat this performance during 2016.

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Fundstrat’s Tom Lee believes that 2016 could be the year that US consumers start to spend some $150 billion of annualized savings on gasoline. This tailwind has yet to materialize, however, based on a 12-month moving average the full benefit of these savings is only just beginning to be felt by households. As a result, a lower gasoline burden should be a strong tailwind into 2016. According to the Department for Transportation, highway miles driven are up 3.5% year-on-year, so there’s already evidence showing that lower gas prices have created a demand response.

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Positive economic factors are just part of Tom Lee’s argument for higher equity prices by the end of the year. Although it may not seem like it, equity valuations are also supportive of higher prices by year-end.

The drop in equity prices has pushed dividend yields to over 2.21% at time of writing, 5 bps above the current 10Y yield of 2.16%. This means that for the first time since the late 1950s stocks now yield more than bonds. (The different is even great when taking into account the differences in taxation.) With inflation and interest rates potentially rising in 2016, equities could once again become the investor’s preferred income investment as dividend yields for equities rise over time while interest coupons are fixed.

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And the last of Fundstrat’s charts looks at the mass-selling of equities by households since the turn of the millennium. The sale of equities by US households is generally cited as evidence to support the argument that a bear market is building. As Fundstrat’s research shows households have actually been “net sellers” of equities since 2001, the largest liquidation in history, although this liquidation hasn’t stopped the S&P 500 hitting new all-time highs. Further, figures show that while households have not been buying equities since 2007, they have plowed cash into bonds, international equities and high-yield funds. Specifically, households have sold $2 trillion of equities since 2007 but have diverted $2.4 trillion into bonds and $1 trillion into international equities for a net gain of $1.4 trillion in these two asset classes alone.

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The post Fundstrat: Why Stocks Will Move Higher In 2016 appeared first on ValueWalk.

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