War. Tapering. Overly optimistic earnings forecasts. They all lurk in future. And yet…
AP The Dow Jones Industrials have gained 109 points, or 0.7%, to 14,942.66 at 12:21 today, on pace for their largest gain since August 1. The S&P 500, meanwhile, has risen 0.8% to 1,653.44, while the Nasdaq Composite has advanced 0.9% to 3,644.51.
Now, today could just be one day. It could be nothing more than a blip as markets head lower. But Morgan Stanley’s Adam Parker and team don’t think so. Parker lifted his 12-month price target on the S&P 500 to 1840 yesterday, despite his view that the market is too optimistic about corporate earnings. He just doesn’t care. Parker explains:
Since 1976, the median year-over-year growth forecast in January for the full year ahead is 14%, but expectations on average decline throughout the year to closer to the 5% average EPS growth we have seen over that period. Why? Analysts (and company managements) start the year optimistic and then adjust their optimism as the year progresses. Analysts often extrapolate or project incremental margin expectations that are excessively optimistic for many businesses. What's our point? The market can work well even as the base case is being revised downward.
In fact, in 28 of the 36 years since forward earnings data have existed in the US, January estimates by bottom-up analysts proved excessively optimistic. In eight years (1984, 1988, 2003, 2004, 2005, 2006, 2010, 2011) estimates were too low. What does this mean? In 6 of the last 11 years, January analyst estimates were too low. These underestimates tended to be in periods of recovery from recessions. As this cycle gets longer and longer, the odds that analysts are being too conservative in their forecasts shrinks.
And tapering? Morgan Stanley doesn’t expect bond yields to head much higher, at least not in the near future. “The government doesn't want to slow the economic recovery, demand for income is enormous, and CEOs are incented to grow their dividends,” Parker writes. “While some tapering is in the price, the rate of tapering is open to debate.”
One group of stocks not feeling the optimism today: Gold miners. With fewer concerns that a U.S. attack on Syria will be disruptive and more evidence that tapering will begin this month, the price of the precious metal has dropped 1.6% to $1,388.90 an ounce–and gold stocks are falling with it. New Gold (NGD), for one, has dropped 3% to $6.55, while Barrick Gold (ABX) has fallen 1.3% to $19.25.
Other losers included Kinder Morgan (KMI), which has dropped 4.5% to $35.90 after being downgraded started as a hold by Jefferies, and Hain Celestial (HAIN) has dropped 2.1% to $80.19 after reports that Carl Icahn has reduced his stake in the company.
MetLife (MET) has gained 3.1% to $48.53, while Prudential (PRU) has climbed 3.1% to $78.29 after Barclays upgraded the stocks to Overweight from Equal Weight Underweight. Analyst Jay Gelb and team explain why:
We missed the initial upside on several of the Life Insurance stocks when Treasury yields began to rise. Even so, investor sentiment should continue to move in tandem with higher yields and result in further valuation multiple expansion for the Life stocks—including MET and PRU. Over time, an earnings tailwind should also emerge, supporting higher forward EPS estimates for the industry…
Rising interest rates and a steepening yield curve are positives for life insurers because of easing pressures on revenues, policy guarantees and hedging costs. Although the benefit to life insurer earnings could be slow to emerge, we expect valuation multiples (which are still low compared to historical levels) to expand.
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