U.S. Portfolio Strategist Tony Dwyer remains positive on the US markets despite China devaluing its currency, deterioration in the global growth outlook and the Fed ready to raise rates. Tony notes that the actual drivers of the U.S. Markets remain in place.
- Low core inflation. Even on an uptick, the core PCE gives the Fed flexibility to raise rates at a more moderate pace than previous cycles.
- Accommodative monetary policy as seen through Real Fed Funds Rate . This measure could rise 100 basis points and STILL be at the best level of the past two cycles.
- Steep/positive yield curve. Every recession since the early 1950s has been preceded by an inversion of the yield curve.
- Uptrend in economic data and EPS. The keystone to our bullish core thesis is the market correlates to the direction of EPS, which continue to be positive despite the dramatic impact from the Energy sector.
- Valuation expansion. The average market multiple when core inflation is between 1-3% is 19x S&P 500 operating EPS, and the current trend in valuation is pointing there, which gives us a SPX 2015 target of 2,340.
Corrections only feel "natural, normal and healthy" until they happen: Tony highlights the fundamental backdrop so often because on event-driven corrections, there is the fear of fundamental change. Only a dramatic change in the credit/money availability backdrop (driven by shape of yield curve) has the power to sustainably change the direction of the economy and EPS - and we believe that is literally years away.
Positive but still waiting for the "all in" signal: The combination of improving economic data relative to expectations, solid fundamental backdrop, millennial demographic trend and recent market selloff (and subsequent rebound) suggests a slight market overweight, with the intention of getting full overweight on a retest of the recent market low, or a breakout to new highs. Tony recommends a slight overweight in those areas driven by improved credit and household formations - the Financial, Consumer Discretionary and Info Tech sectors, while a slight underweight in the Energy, Materials and Industrial Sectors.
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