U.S. Equities: Burden Of Proof Lies With The Bulls

2100 has been a key resistance level for the U.S. S&P 500. We believe the market lacks a near-term catalyst for a breakout above that level. Conversely, several factors risk pulling the market down.


It is unlikely that economic data between now and the next FOMC meeting (on December 15-16) will be poor enough for the Fed to back off from raising rates; there remains one payroll report and inflation data. Equity prices have been steady over the past few weeks, i.e. since it has become apparent that the Fed’s default position is to raise rates at the next meeting.
But still, at nearly 16.5 times forward earnings, stocks are priced for a very good earnings/economic outcome. We have highlighted frequently in Daily Insights that we view most of the risks to the downside. Dollar strength represents monetary tightening and is a headwind for many S&P companies. Corporate selling prices are weakening, putting downward pressure on profit margins. EM risks remain elevated. We are on high alert for more severe corporate bond fallout, especially in the energy space.
In sum, it is not a recipe for broad market capital appreciation. The Fed may not be the trigger, but we nonetheless remain defensive and focused on minimizing risk.


Autumn euphoria has taken over from summer panic, and global equity bourses are making a run at all-time highs. However, markets are becoming unhinged from still deteriorating earnings fundamentals.

The diverging monetary policy backdrop, with the Fed on one side and nearly every other central bank on the other, remains intact. Importantly, the Fed has recently signaled that it is ready to lift interest rates as soon as next month. All of this has caused the U.S. dollar to spike, intensifying the threat of an emerging market (EM) financial accident, as discussed in our September 25 Special Report titled “The U.S. Dollar Debt Hangover: Sectors And Regions To Avoid”.

The risk is that U.S. dollar-induced global deflation will accelerate, causing a relapse in commodity prices at a time when global trade is at a standstill.

Global Alpha Sector Strategy’s global earnings-per-share (EPS) model (an equally weighted composite of all of our sector EPS models) does an excellent job capturing this deteriorating macro backdrop, and is currently signaling more earnings pain heading into 2016 (top panel). Worrisomely, sell-side analysts are penciling in near double-digit EPS growth for the coming year (top panel).

Since the early 1980s, global equity profits and operating earnings margins have been inversely correlated, albeit with a lag (bottom panel). Profit margins are mean reverting, as high margins tend to bring in more competition from start-ups, small- and mid-caps, non-listed, intra- and inter-industry and foreign firms that eat into profitability of incumbents. The opposite is also true. Thus, the current high level of margins should be seen as a harbinger of softer profitability ahead (bottom panel).

imageAgainst this backdrop, it is prudent to maintain a defensive over cyclical portfolio bias, a message corroborated by our defensives vs. cyclicals EPS models (not shown).

For additional information, please visit the Global Alpha Sector Strategy website at gss.bcaresearch.com.