What to Do Now

Midyear Forecast from Allen Sinai

sinaisforecastThere’s plenty of caution and gloom on Wall Street this year. That’s because investors are facing weak corporate earnings, meager global economic growth, rising interest rates in the US and a topsy-turvy presidential contest. But does that mean we’re approaching the end of the seven-year-old bull market—the third-longest in US history? Top economist Allen Sinai tells Bottom Line Personal that the stock market will have to claw its way to moderate gains this year but should gain speed in 2017—and that the bull market might last into 2019.

Here’s why…

We’re in a Standoff

Through much of this year, we are looking at a mucky stock market that moves up and down in a tight range and produces disappointing returns, at best 5% for the year including reinvested dividends. But investors shouldn’t confuse a sideways market with a dying one. The economy has been too weak to lift stock prices higher but strong enough to prevent a recession or a bear market.

The impasse is temporary. There are catalysts that investors are underestimating, and they eventually will reinvigorate the current bull market. These include robust employment, a strong housing market and continued low interest rates even as the Federal Reserve moves cautiously to slowly raise ­short-term rates. I expect the Fed to end up raising its benchmark rate only twice this year to avoid slowing down economic growth. And although consumer spending was tepid in the first quarter of this year, consumers’ household balance sheets are in much better shape than they were before the last recession. Household debt as a share of disposable income stood at 105% recently, far ­below the dangerous level of 133% reached in the final three months of 2007. Moreover, a tightening job market is pressuring employers to raise wages. That should fuel further gains in disposable income.

Stock valuations remain reasonable. The price-to-earnings ratio (P/E) of the Standard & Poor’s 500 stock index was recently 18, not much higher than its long-term historical average and far below the P/Es above 30 at the start of bear markets in 2000 and 2007.

Breaking the Impasse

Investors won’t start bidding up stocks until they see signs that corporate earnings will start rising significantly. That likely won’t happen until late this year or in 2017 and will require several breakthroughs in the economic outlook. What to watch for…

The rest of the world starts pulling its economic weight. Europe is already improving, but Japan and China have remained notable laggards this year. The Japanese economy expanded by an ­annualized rate of 1.7% in the first quarter, the fastest pace in a year but still not strong enough. I am encouraged by the Bank of Japan’s ongoing plan to stimulate the economy, including its purchases of government and corporate bonds, but this needs to be stepped up.

In China, the economy advanced at a rate of 6.7% year-over-year in the first three months of 2016, its weakest quarter in seven years. But I’m predicting that the government’s aggressive stimulus efforts will arrest the slowdown in economic growth and set the stage for improvement this year and next year.

Inflation rises above 2%. Low consumer prices sound beneficial but actually can stall growth for businesses because low inflation can mean weak revenues. We should start to see greater increases in consumer prices over the balance of this year, in part because of higher crude oil prices. The decline in US oil production and disruptions in oil output in Iraq, Nigeria and Canada have removed about 1.6 million barrels a day of production—or more than 1% of global supply—and global demand is rising again.

I expect oil prices to rise to $57 per barrel by year-end 2016 and $65 by year-end 2017, compared with prices below $27 earlier this year. That will spur some inflation without hurting consumer spending. Better performance by major energy companies also should boost overall corporate earnings for the S&P 500.

The greenback weakens. The US dollar was on a tear from mid-2014 to late last year, gaining 20% against a basket of major foreign currencies. That hurt S&P 500 corporations, which derive nearly half of their sales from foreign countries. This year, however, the dollar has fallen more than 3%. A weaker dollar helps US exporters by making their products more affordable to consumers in foreign countries.

Political Uncertainty

The stock market doldrums have been exacerbated by the presidential race. On the Republican side, ­Donald Trump’s protectionist trade threats and unpredictable stance on foreign relations worry Wall Street. Democratic candidate Hillary Clinton is a better-known quantity, but her positions regarding stricter Wall Street regulation and tax increases are not investor-friendly.

After the November election, just having a better sense of what might be ahead over the next four years in Washington, DC, will help relieve investor angst. I believe the best outcome that investors can hope for is divided government. The stock market can perform well when one party controls the White House and the other controls Congress because that split creates gridlock and reduces the chance of legislation that involves sweeping changes.

Key Economic Measures

Here’s what I expect…

GDP: The US will start to resolve some of the uncertainties that the economy faces, and gross domestic product will grow by 2.2% for the whole year, compared with 0.8% in the first quarter of 2016. By 2017, we will see more satisfying economic growth, with GDP increasing by 2.8%.

Unemployment: The jobless rate, which was 5% for April, should fall to 4.4% by the end of 2016, with an ­average gain of about 200,000 jobs per month. The rate will continue to drop to 4.1% by the end of 2017.

Inflation: As measured by the Consumer Price Index (including food and energy), inflation will remain tame for 2016 at a rate of 1.5%. But rising prices for medical care, housing and energy will restore inflation to more normal levels above 2% for 2017.

The Outlook for Stocks

I expect the Dow Jones Industrial Average to rise to 18,300 by the end of 2016, up 5% for the year. The S&P 500 should hit 2,125, a 4% increase for the year. Corporate earnings likely will grow a meager 2% to 3% for 2016. However, a pickup in both the US and global economies should boost earnings by 6% to 8% in 2017, helping to produce better stock market returns.

Best sectors of the stock market now…

Health care. This will be perhaps the fastest-growing part of the US economy as the population ages…the Affordable Care Act means more people are covered by health insurance…and drug prices continue to rise sharply.

Industrials. They look undervalued and will be helped by a rise in inflation. Stronger global growth will boost exports for US manufacturers.

Sectors to avoid…

Utilities. These stocks face sharp declines because of the Fed’s interest rate increases.

Energy. Wait for further signs of a sustained turnaround in oil prices. Energy stocks could then look very ­attractive.

The Outlook for Bonds

Yields on 10-year US Treasuries are likely to remain low and wind up the year around 2.4%, slightly higher than at the beginning of the year and not drastically higher than the recent 1.84%. Fixed-income investors should shorten the ­maturities of their bond holdings. Reason: Higher inflation in 2017 will mean at least four rate hikes from the Federal Reserve that year. While these increases will be gradual enough not to disrupt the stock market, they would mean negative returns for bonds.

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