Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Joseph Amato, president and chief investment officer of equities at Neuberger Berman urges investors to exercise caution during this US ‘relief rally’.
Traditionally, equity people are supposed to be more optimistic than bond people, but I am prepared to buck the stereotype just a little as we begin the first quarter earnings season. I am not about to argue that we have inflated a bubble and stand on the brink of savage correction. Nonetheless, I think it is fair to say I am a little more circumspect.
The market pendulum tends to swing too far in both directions. Does the simple recognition the world is not about to end explain why the S&P 500 Index went up more than 15% in 10 weeks? At 17-17.5 times forward earnings, US large caps will not look particularly cheap should run-rate earnings for the first three months of 2016 come in at around $100-$105 per share, as seems likely. That is a long way from the $120-$125 per share that we feel is required to support today’s multiples.
Amid the headline-grabbing extremes of pessimism, the more sober talk in January and February was of an earnings recession, and I do not see anything that has fundamentally changed that narrative.
For sure, the dollar strength has eased – but wasn’t that already underway by the second half of 2015? And yes, energy may be less of a drag this year—but does it follow that we are about to see break-out numbers from the financial, industrial, or consumer sectors?
Banks Reveal Troubled Earnings
Financials are especially important as it is difficult to sustain a rally of this strength while banks are struggling to generate positive earnings. First quarter earnings from JPMorgan Chase, Bank of America Merrill Lynch, Wells Fargo and Citigroup have been released. We are used to the game in which analysts set expectations so low they are almost impossible to miss: JPMorgan’s earnings per share beat the 13% slide that had been estimated. But the real takeaway was simple: the largest bank by assets in the US saw its earnings fall by 7%. The reports for Citigroup, Bank of America and Wells Fargo told a similar story, with capital markets weakness hurting the first two and energy exposure the latter.
Elsewhere, some good news emerged out of Italy last week, as a better-than-expected support programme was thrashed out for its struggling lenders. However, on the whole, European banks have performed poorly despite the expansionist policies announced by the European Central Bank in March. Dealogic estimates revenues in global investment banking are down 36% year-on-year, which would represent the toughest first quarter since 2009.
This background explains the elements of caution that underlie this rally in US stocks. Small caps are still down year-to-date. The big value sectors that bore the brunt of the sell-off in the New Year – energy, materials and industrials –are up 6-8%, but the other big performers are defensive consumer staples and utilities.
I believe this is a ‘relief rally’ that lacks a degree of conviction and is really a response to the excessive pessimism of the New Year. Again, to be clear, we are not talking about extremes in valuations. But the pendulum has swung far enough that I do not feel compelled to chase this market, and I would need to see much firmer evidence of an earnings revival over the coming seasons to change my mind.
Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com
