Politicians – namely the Federal Reserve and the White House – may have succeeded in pulling the US economy back from the brink and clearing the path for equities most sensitive to the business cycle to compete over the next six months or so, according to a top strategy on Wall Street.
Barry Bannister, head of institutional equity strategy at Stifel, gave a precise warning last year ahead of the fall in the stock market in the fourth quarter. Bannister then believed that the Fed had tightened monetary policy too much and would eventually need to cut interest rates. And even as the Fed moved into relief this year, Bannister asked if the relief would be enough to offset the past mistakes and avoid a recession.
Since that time, last month delivered his third interest rate cut on the easing cycle. And more importantly, it has adopted what Bannister described as "quasi-QE" when it pledged to increase the size of the balance sheet in response to a rough update in money markets that saw the central bank briefly lose control of the key interest rate in September. QE or quantitative easing refers to the establishment of banking system reserves by a central bank that financial institutions can then use to buy bonds or other assets and effectively inject liquidity into the markets.
On the international trade policy front, the United States and China, meanwhile, are heading for a "phase one" agreement that would address some of the disputes between the world's two largest economies and take some of the heat out of the long run
“The Federal Reserve, by shrinking the balance, and the White House, by waging a trade war, skated very close to the ice edge and risked a recession. Both support something, and it's positive for global sentiment, "said Bannister, in a Thursday interview. When the safe harbor flows easily and in turn contributes to raising oil prices, the lower geopolitical and monetary policy risks are also positive for the reflection trade, which can further raise state interest rates as nominal economic growth recovers – a boon to financial equities.
Bannister sees the return on the 10-year Treasury
TMUBMUSD10Y, + 0.38%
increasing to 2.25%, compared to around 1.91% on Friday. As Bannister stated in a note on October 13, this should favor cyclical sector stocks in general, including economy, energy, industry, technology and materials. Stifel, for his part, shifted away from an overweight position in defensive stocks and bondholders.
Earlier this week, Bannister built on its positive conversation, predicting the cyclical upturn that will last next year, and set the S&P 500 index
SPX, + 0.01%
actual value for 2019 of 3,050, up from 2,900 or a shade below the last level. Right up to 2021 seems restrained, with Bannister setting a fair value of 3,100.
In a note, Bannister emphasized that the next six months "are about cyclic alpha, not the S&P 500 beta."
As for the energy sector, Bannister argued that it should benefit from an increase in oil prices. His optimism against crude oil not only centers on the prospect of a weaker US dollar, which has tended to trade in a reverse relationship with crude oil, but also results from heavy speculative short positions on Nymex oil futures that often act as a counter-indicator. Throw in Saudi Arabia's incentive to raise oil prices ahead of the launch of a first public offer for state-owned Saudi Aramco, and the path to higher crude prices seems relatively clear, he said.
Longer term, the outlook for the overall stock market is of course less clear. Some of the issues that have been kicked down the road could be brought to a head in 2020, Bannister said, including the potential for renewed tensions in the US and China around issues not resolved by a "phase one" trade agreement.
An American presidential election is also approaching next year. Bannister claimed that a victory by Democratic challenger Elizabeth Warren – whose calls for wealth tax and increased regulation ring alarm bells on Wall Street – could be an "unsolicited disaster for capitalism and many industries," including financial services and the energy sector. That said, any victory is likely to be limited by a divided government.
"All in all, it looks like a six-month call now, and we'll take a look next spring … So we have a lease on the market, with an opportunity to buy," Bannister said.