The booming stock rally may have room yet to rip even higher.
That’s according to Citigroup, which modeled market data to find that odds favor bulls in 2020.
“We tried to normalize the earnings yield-gap analysis, we tried to normalize earnings through what’s called cyclical adjusted P/E, and we take the five-year forward contract for the 10-year yield to say, ‘What do markets believe the 10-year yield will be, not today, but in five-years’ time?'” Tobias Levkovich, Citigroup’s chief US equity strategist, said in a Bloomberg TV interview on Thursday. “And it’s generating a near 90% probability of higher markets in the next year.”
Falling interest rates have pushed bond yields lower, driving return-hungry investors to stocks in part because they see few alternatives. The S&P 500 climbed to a record on Thursday, and the Nasdaq smashed through the 9,000 level for the first time.
While there’s plenty to worry about in the economy in 2020 that could torpedo the market — including slowing global growth, an escalating trade war, and election uncertainty — the low-rate environment looks like a constant. For now.
Citi’s Levkovich told Bloomberg that according to the bank’s survey of investors, “the Fed’s not doing anything until 2021.”
That could push stocks higher.
“One of the reasons bond yields are so low is the fear that we don’t get good enough growth, the fear that we’re not going to get the inflation, and as a result, you get a higher equity-risk premium that offsets some — not all, but some — of the low-bond-yield aspect,” Levkovich told Bloomberg. “So valuations could move higher, clearly where we are today.”
Earnings growth next year will also shore up equities, Thomas Digenan, UBS Asset Management’s head of US intrinsic value equity, said in the same interview segment on Bloomberg TV.
“The overall market, in this interest-rate environment, is really attractive,” said Digenan. “We’ve gone through about five years where investors can’t believe the interest-rate environment we’re in. It’s real, and I think multiples should be adjusted.”
“We get some positive kick from the earnings, and as a result, you get a better market,” Levkovich said.
But he noted that despite signs of further gains, many investors are fearful, and see limits to the euphoria.
Citing the bank’s survey, Levkovich said that more than 70% of respondents “think that you’re more likely to see a 20% correction than a 20% rally,” he said. “They’ve seen this rally, they’re a bit concerned, maybe it’s gone a bit too far, and money flows continue to come out of markets. Investors still are, if you like, cashing in their chips.”
“I think investors are probably going to need earnings to convince them, and bring them over the hump.”