Sam Stovall: S&P's 2016 Outlook

01/01/2016 9:00 am EST

Focus: STOCKS

Sam Stovall

Chief Investment Strategist, CFRA Research

The S&P Capital IQ Investment Policy Committee foresees 2016 as a good—but not great—year for US equity markets. Here are the economic fundamentals and historical considerations contributing to our outlook, says Sam Stovall of S&P Capital IQ in Standard & Poor's The Outlook.

We forecast the sub-3% GDP growth trend continuing. Specifically, our economists say US GDP will likely increase 2.7% in 2016 and remain below 3% annual growth through the end of the decade.

Meanwhile, the Fed funds rate is predicted to rise to 1.25% by the end of 2016. Additionally, oil prices will likely stop falling in 2016, but the dollar should stand firm. Oil prices are seen averaging $50 a barrel in 2016. In the meantime, the US dollar is predicted to continue to rise on a trade-weighted basis.

The S&P 500 (SPX) should post 8% earnings per share growth: Capital IQ aggregate estimates see S&P 500 EPS rising to $126.44 by yearend 2016, with gains in all sectors but energy. The S&P Capital IQ Investment Policy Committee set a 12-month target of 2,250 for the S&P 500.

From a sector perspective, we favor the consumer discretionary, healthcare, and telecom sectors, but we advise underweighting energy, materials, and utilities, due to higher rates and dollar forecasts.

From a global asset allocation perspective, foreign equities offer similar growth estimates but lower valuations: Foreign developed, emerging, and small-cap markets trade at discounts relative to US markets.

From a historical perspective, a good year usually follows a flat one: Since WWII, there have been ten times that the S&P 500 rose or fell by less than 3% in any calendar year.

In the subsequent year, it gained an average 12.8% and rose in price 80% of the time. Only in 1947-48 was one flat year followed by another flat year.

Election-year results are usually solid: The S&P 500 gained an average 6.1% during the fourth year of the presidential cycle since 1948 and rose in price 76% of the time. In addition, small-cap stocks gained in price an average 10.9% and rose in 78% of all election years since 1980.

From an equity investment perspective, S&P Capital IQ thinks global equity investors will continue to favor the US, due to stronger and more transparent economic and corporate profit growth forecasts.

Specifically, S&P 500 earnings per share (EPS) are expected to advance 8.0% in 2016, after the projected 0.7% decline in 2015. Not far behind, international developed, emerging, and frontier markets, as well as small-caps, are projected to post EPS growth ranging from 6.4% to 16.1%.

To this end, the S&P Capital IQ Investment Policy Committee recommends investors with a moderate risk tolerance keep 45% of assets in domestic equities, 15% in foreign stocks (10% developed and 5% emerging), 25% in bonds, and 15% in cash.

S&P Capital IQ’s Investment Policy Committee thinks equities remain the asset class of choice. We therefore recommend that investors maintain the equity exposure that is appropriate for their time horizon and risk tolerance, but advise them not to go too far out on the risk curve.

This bull market is long in the tooth. At more than six and a half years old, versus an average of four and a half years since WWII, it may be held back by rising rates, below-par economic and corporate profit growth, and elevated valuations.

We don’t see a global recession on the horizon, and we prefer US equities to international ones. The prospect of gradually rising rates in 2016 leaves investors with few attractive investment alternatives to equities.

We suggest underweighting but not avoiding bonds, the only negatively correlated asset to stocks. In all, we label ourselves “bulls,” but emphasize a lower case “b.”

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