- Flickr/Marion Doss
The S&P 500 this week jumped to new highs, leaping above the median Wall Street year-end target of 2,152.
Naturally, there were expectations that strategists would begin to raise their targets.
But in a note on Friday, BMO chief investment strategist Brian Belski said he’s sticking to his target of 2,100, outlining two reasons why now is not the time to become more bullish.
“From our perspective, they are ones that investors are not necessarily prepared for: at least one more Fed rate hike and a transition to an EPS from a P/E-driven market environment,” Belski wrote.
The Fed’s intentions appear split in two. Markets believe the Fed will not raise interest rates this year, although it has said it intends to at least once, and economic data support this.
After Britain voted to leave the European Union in June, bets that the Fed will not raise rates increased. That’s a big part of why stocks recovered so quickly after the sell-off, Belski said.
- BMO Capital Markets
But investors are being “somewhat irrational” because the Fed’s messaging on one or two possible rate hikes this year has been consistent.
If the Fed raises rates, stocks could sell-off and then recover sharply like they did in December after the initial rate hike, Belski said.
Pantheon Macroeconomics’ Ian Shepherdson shared a view along these lines on Twitter, writing that Fed officials are likely to become more vocal about raising interest rates.
“Just a heads-up, because usually when this happens you get all upset,” he wrote.
Belski’s second reason for not raising his forecast is that the driver of stocks is likely to change from higher valuation to earnings. And it won’t be a smooth transition.
Since 2014, earnings growth – usually the most important driver of stock prices – has steadily declined, while the price-to-earnings ratio has climbed.
- BMO Capital Markets
“The good news is that current expectations suggest just that – a sharp earnings rebound is in store for 2H16 and beyond,” Belski said.
“The somewhat bad news is that we do not believe investors fully understand the implications of what an ‘earnings-driven’ environment may mean for stock market performance,” especially in the short term.
Belski’s year-end target of 2,100 is the second lowest among analysts at major firms tracked by Bloomberg. It implies a 4.3% gain for the S&P 500 this year.