Deutsche Bank’s Binky Chadha is normally pretty bullish.
But for 2020, he’s keeping the same S&P target (3,250) that he adopted for 2019. It’s fair to call that “cautious”.
“This would represent a very modest increase (+3.5%) from last week’s close”, Chadha wrote, in a note dated Monday. If we see any serious upside over the next four weeks, the 3,250 target for next year “would imply a sideways market”, he adds.
His subdued outlook is predicated on a handful of factors. One is that valuations are rich, “having been higher only 10% of the time over the last 85 years”, Chadha says. The following visual shows the distribution:
(Deutsche Bank)
In addition to stretched valuations, it’s also somewhat worrisome that stocks may have already priced in a meaningful inflection in the macro data and a robust rebound in earnings growth. Specifically, Deutsche says the S&P has priced in “ISMs rising to around 57 and earnings growth to 15%”.
(Deutsche Bank)
To call that optimistic seems like an understatement. After all, we just got a disappointing ISM manufacturing print for November (the fourth contractionary read in a row) and earnings growth flatlined in the third quarter.
A modest rebound in profits is expected in Q4, but what happens after that is up for debate, especially considering possible margin headwinds from tariffs, rising wages and trouble passing on higher costs to consumers.
In addition, Chadha says “a tight election should see markets start to price in uncertainty by the middle of next year”. Oh, and then there’s the ambiguity around the course of trade policy, something market participants were reminded of this week.
For Deutsche Bank’s equity strategists, both the proximity of the election and the fact that US stocks have once again summitted new peaks makes a resolution to the multi-front trade war unlikely.
“The Trump election platform looks to have been to keep trade frictions alive but as the consequent economic slowdown began to show up in voter perceptions of the economy–historically the key driver of Presidential election outcomes–there may have been a scurry to reach agreement”, Chadha remarks, on the way to suggesting that “the proximity of the election makes any sweeping agreement unlikely, extending the fundamental uncertainty emanating from US trade policy that has plagued corporates and been a key driver of the US and global economic slowdown”.
He then reminds investors that “past market peaks [were] followed by major trade escalations”. Traders may have seen the beginnings of another such “major” escalation this week.
Note the bit above on trade uncertainty “plaguing” corporates. We’ve been over that at length in these pages, including on Sunday in “‘Stunning’ Gap Between CEO Confidence And Stocks Still Raising Alarm Bells“. Here’s Chadha’s take:
While there are many policy and other uncertainty indices, we focus instead on corporate CEO confidence, which we see as a key channel whereby policy uncertainty is transmitted to the economy. The Conference Board’s CEO confidence index has historically led the ISMs by 1 quarter and GDP growth by 2 quarters. A phase I trade deal argues for a break in the downward trajectory of growth and perhaps some bounce, but not a rebound back up to prior peaks that the market is pricing. We note that the Conference Board’s CEO sentiment index is already down at levels previously seen only in recessions and points to a continued slowing in growth over the next 1-2 quarters as is our economists’ view.
Again, none of the above is to suggest that Deutsche’s house call on US equities is overtly bearish – it’s not. 3,250 still represents some upside, and if stocks keep doing what they’ve been doing over the last three sessions, it may start to represent even larger gains for anyone inclined to buy the early December dip.
But, as is probably clear from the above, at least one bull is exercising a bit of caution at a critical juncture both for markets and geopolitics.
