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The 2013 stock-market rally was stopped in its tracks by a rough June, but it's only temporary – there's a 10-per-cent rise in the works for the S&P 500 over the next 12 months.
The 2013 stock-market rally was stopped in its tracks by a rough June, and it looks like the start of a full-scale correction – expect flat returns for the S&P 500 over the next 12 months.
Both of these divergent stories are being told simultaneously by Wall Street analysts – some looking at the market forest from 30,000 feet, others who are down among the trees. They can't both be right.
Independent market analysis firm FactSet Research Systems Inc. took the average 12-month price targets for each S&P 500 stock from analysts who cover specific companies and industries, and compared them with current prices (a so-called "bottom-up" analysis), to come up with an S&P 500 price expectation of 1,769.03 – 10.1 per cent higher than the closing level of 1,606.28 on June 30. Pretty nice, right?
But FactSet also took the average 12-month target price for the overall S&P 500 from the equity strategists who look at the broad market as a whole (a so-called "top-down" analysis), and came up with 1,611.25 for the S&P 500 a year from now – just 0.3 per cent higher than the June 30 close. What's more, the top-down expectations point to stocks continuing their slide into the summer, wiping out about 15 per cent from the index's May highs, and not drifting meaningfully upward again until 2014.
FactSet noted that over the past 12 months, the bottom-up analysts were much closer to making the right call than the the top-down analysts; indeed, the top-down outlook didn't anticipate this year's rally at all. But bottom-up forecasts are notoriously bad at recognizing big-picture macro pivot points – and it feels like we're pivoting here.
Crucially, the all-but-certain tapering of the U.S. Federal Reserve's monetary stimulus has heralded the likely beginning of a long-term trend toward rising interest rates. This fundamentally alters the investing proposition for stocks. Higher rates – especially if not accompanied by particularly robust economic expansion, as is the case now – are historically bearish for equities, drawing investors to the improving returns on low-risk assets such as bonds, which typically pushes down price-to-earnings valuations on stocks.
That alone would suggest a 10-per-cent rise in stocks over the next year is wishful thinking. But that's not the only headwind stocks face.
Government austerity, especially in the United States but also in Canada, will weigh on already tepid economic growth. In Canada, you can add a housing-sector slowdown that has yet to drop its second shoe – an expected pullback in prices, which could present a significant drag to economic growth over the next year.
Toss in problems in China and the euro zone, and it's hard to write a compelling growth story. And with profit margins near historical peaks, it's equally hard to see how companies can squeeze any more profit growth out of this lukewarm economic growth scenario.
It simply doesn't add up to a new up-leg in the stock market's rally. Those looking at the trees are missing the plethora of forest fires heading their way.
David Parkinson is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights, and follow him on Twitter at @parkinsonglobe .
David Parkinson