The bull market is seven years old and looking tired. Many strategists and money managers believe that this old bull won't see a cake with eight candles because there isn't enough earnings growth and investors won't expand P/E multiples anymore.
Bullish investors' hopes will, of course, be kept alive by the steadily expanding economy, which, despite slow growth of 1-2%, is supported by the extremely accommodative Federal Reserve.
History proves it's very rare to have a bear market without a recession, and with a very friendly yield curve. And so hope springs eternal that earnings growth can and will return... next quarter.
But it's Wall Street institutions that move the market. And the buying is slowing down. In this report, we'll hear from four of the biggest and smartest, all who refreshed a "neutral" stance on US equities in the past month.
Goldman Sachs (NYSE:GS)
All year, I have been closely following the research and analysis of the team led by David Kostin, chief US equity strategist at one of the most influential houses on Wall Street. He's been subdued about equities all year, primarily because of the earnings recession.
But this week, he made the picture even darker by analyzing current and projected equity fund flows.
The Kostin team slashed their 2016 estimate of US demand for equities by nearly half to $125 billion, citing a weaker appetite for stocks among retail investors as the market struggles to break free from its range-bound trading amid global uncertainty.
The Goldman quant had initially projected equity demand of $225 billion for this year, with $325 billion in foreign stock purchases by US investors and $50 billion in credit investments offsetting $600 billion in gross demand.
"We now estimate gross equity demand of $500 billion and overall US equity net demand. Inflows into equity mutual funds and ETFs -- and by extension demand for shares -- will be less than we had originally forecast," Kostin said in a Monday morning note.
On May 31, Richard Turnill, Global Chief Investment Strategist for BlackRock wrote, "We've downgraded our near-term outlook on equities to neutral. Uncertainties around the Fed and strong returns on global stocks suggest taking a more cautious approach."
The BlackRock team cited the growing likelihood of an imminent Fed rate increase and more elevated US valuations as warranting short-term caution.
"U.S. stocks have been in a sweet spot since mid-February, supported by solid economic growth and falling real yields on the back of expectations of a Fed on hold. Yet yields have started rising again. Higher U.S. inflation and hawkish Fed comments have now put a summer rate increase back on the table, increasing investor anxiety and the likelihood of near-term volatility."
They also believe that global stocks look vulnerable because equities no longer look cheap. Obviously, he's referring to how attractive they looked back in February. Now, all the best news, like the oil price recovery and the cautious Fed, seems very priced-in.
"And stocks overall appear more vulnerable to short-term risks. These include a Fed that increases rates too aggressively, a Brexit, a worsening European immigration crisis and a slowdown in global growth. We also see less upside to China's growth expectations after a recent uptick in activity, and oil prices have rebounded a long way and now reflect improved fundamentals."
Bank of America/Merrill Lynch (NYSE:BAC)
BofA/ML has been cautious this year almost as long as Goldman Sachs. In late May, they updated their somber view of this summer's prospects for equities.
US Equity & Quant Strategist Savita Subramanian sees an increasing number of trends that worry her as we head into summer. Concerns include: 1) the Fed tightening into a profits recession, 2) tightening standards in the capital markets, 3) a seasonally weaker oil price in Q3, 4) political uncertainty in the US, and 5) the EU referendum.
Of additional concern, May-October historically has been the seasonally weakest six-month period of the year. Subramanian notes negative sentiment and positioning as a positive and maintains her year-end S&P target at 2000.
Regarding oil, she says to get ready for the second leg down in the oil price "W," referring to the necessity of a double bottom of some sort in the future.
"Our house forecast for a W-shaped recovery in oil prices suggests seasonal weakness in 3Q with WTI falling over 15% before it recovers in the fourth quarter. The S&P has moved in lockstep with WTI, suggesting near-term downside."
And on the election, the BofA/ML team says, "Uncertainty is rarely good for markets, and as we move closer to November with many policy unknowns for both presumptive nominees Trump and Clinton, uncertainty is likely to be even higher than it is ahead of the average election. There is a 44% correlation between the US Policy Uncertainty Index and the VIX."
On June 10, Fidelity's director of global macro, Jurrien Timmer, appeared on CNBC's "Squawk Box" and summed up the neutral-to-bearish case in 1 minute...
"We're in this bull market purgatory, if you will, where we're not firing on all cylinders. There's no earnings growth," Jurrien Timmer told CNBC's "Squawk Box."
"The market math is pretty simple, right? If the market is going to break out, it either needs earnings or it needs P/E a boost."
That price-to-earnings ratio boost is unlikely, according to Timmer. That's because it would require the Federal Reserve to abandon its plans to raise interest rates or a change in investor sentiment - neither if which he foresees.
At the same time, Timmer said there are few signs US companies will deliver aggregate earnings growth for the second quarter.
Where Do I Stand?
I don't argue with large institutions that are going neutral on stocks after a long bull run. Sometimes their "neutral" is code for "sell." Smart or not, their influence is undeniable.
And like them, the earnings recession is still the biggest concern on my mind. It automatically spells lower stock prices as long as the forward estimates are still in jeopardy. It's one thing to pay 18 times forward earnings that are still on an upward trajectory. But you don't pay that for earnings on a downward glide path.
And right now, with full-year 2016 estimates for the S&P 500 slipping to $115 (from a projected $130+ this time last year), the S&P at 2100 is trading over 18X. If those estimates fall, the market keeps getting more expensive. And I think that makes most fund managers net sellers until signs of growth return.
This is what I have believed all year, and yet the market continues to levitate near S&P 2100 as if a Brexit vote outcome of "Remain" will somehow be the catalyst for new highs.
I wouldn't hold my breath.
When you consider the evidence:
- the neutral-to-bearish tone of so many institutional investors...
- the earnings recession...
- how overpriced stocks are right now...
- and the fact that this bull market is over 7 years old...