The S&P 500 could advance by 10-20% this year, but investors should hold off on buying for the next few weeks, according to Chris Watling, the CEO of independent financial research firm Longview Economics.
In a note published this week, Longview said its current market timing models are close to “sell” for the U.S. index, since risk appetite has become “greedy” and markets are “complacently priced.”
U.S. stocks jumped to record highs on Thursday as tensions between Iran and the U.S. cooled, with the S&P 500 closing 0.7% higher at 3,274.70. The index has surged 26.68% over the last twelve months. Watling recommended remaining “neutral” while high levels of risk appetite and sell signals unwind.
The latest AAII Sentiment Survey published on Thursday placed pessimism among individual investors at a six-week high. Bullish sentiment for the next six months is seen falling 4.1 percentage points to 33.1% versus a historical average of 38.0%. Bearish sentiment, or expectations that will stocks will fall over the next six months, jumped 8.0 percentage points to 29.9%.
However, a re-acceleration of the “mini cycle” in the U.S. economy and central bank “largesse” mean the outlook for the first half of 2020 is positive.
“In this economic cycle (except for 2017) whenever the (Federal Reserve) has been expanding its balance sheet, the S&P 500 has been trending higher, and whenever it has stopped (or contracted its balance sheet), the S&P 500 has trended sideways/sold off,” the Longview note highlighted.
“With this latest Fed repo program that balance sheet expansion has recently begun once again (supported by interest rate cuts).”
The S&P 500 is trading around 18.6 times forward earnings, a considerably higher valuation than the 16.7 times average of the last five years and 14.9 times average over the last decade. The forward price to earnings (PE) ratio is a current stock’s price over its projected earnings per share.
However, Watling told CNBC’s “Squawk Box Europe” on Friday that valuations have little bearing on the anticipated 12-month returns for the index.
“On a standalone basis, the market looks expensive, but actually if you look at it on a relative basis, it’s very cheap,” he said.
“If you look at it relative to high-yield credit, relative yield spread, or if you look at it relative to sovereign bonds, then actually it is exceptionally cheap, so it depends how you think about it.”
Watling also anticipated a slight rotation away from high-valued tech stocks on the S&P 500 into cyclicals, which may ease some of the perceived excessive valuation among the basket of big name tech players in the index. Cyclicals are those stocks whose price is impacted by macroeconomic trends.