As June draws to a close, Mike Gibbs, Managing Director of Equity Portfolio & Technical Strategy, discusses earnings growth and current valuation levels.
June 27, 2017
The U.S. equity market remains on healthy footing, in our view. Earnings momentum is strong, economic conditions are okay, and competing assets offer paltry yields. The lack of progress on the headline political agenda has not been a setback as of now due to the exceptional earnings growth posted by the equity market in 1Q. We think the market is likely receiving a favorable boost by actions of the Trump administration to reduce regulatory constraints put in place by the Obama administration. Technically, the recent rotation (large cap tech into financials, industrials, and healthcare) is a healthy sign to us that investors are not eager to remove funds from the market when they book profits.
The market backdrop and our outlook remain positive; however, the S&P 500 has gained just under 20% over the past seven months. It is also trading at a valuation we view as full. These are two reasons influencing our opinion that the upside will be limited over the near term. We believe a basing period is likely to allow the market to digest the recent gains. In the process, the premium valuation should be lessened as earnings are expected to continue a healthy rate of growth. Also, investors should be given additional time to assess the potential of political success with the Trump agenda as well as analyze the health of the U.S. economy.
Absent any major setbacks economically (something we do not envision), any developing pullback periods are expected to be limited. Initial technical support levels near 2400 reaffirm the potential limited downside. Even in the case of a shift in investor sentiment to the negative, technical support levels just above 2300 (‐5%) suggest limited downside in the scope of normal market pullbacks. As a reminder, the average maximum annual drawdown for the S&P 500 since 1980 is 9% (excluding bear market years).