The real upside, Steve Auth says, could come post-election.
Published February 20 2020
Linda Duessel: Hello and welcome again to the Hear and Now Podcast. I'm Linda Duessel, Senior Equity Strategist at Federated Hermes, and Today, I'm joined by Steve Auth, Chief Investment Officer of Global Equities. Hello Steve.
Steve Auth: Hi Linda.
Linda Duessel: Hi. Gosh, I remember at the beginning of last year when I asked what your forecast was for the S&P 500 for the year end 19, you called for 3,100 which looked really heroic at that time, and of course as we know, we finished the year even above that, so congratulations on an excellent call.
Linda Duessel: Now you've come out this year for 2020-
Steve Auth: Wait a minute, just, I mean, there's a whole team behind that call, okay. So good for them.
Linda Duessel: Excellent. But You've come out this year with 3,500 target for the year end, which is also on the high end of consensus out there. Can you help us with what are the factors that are driving your bullish call?
Steve Auth: Well, I'd like to know the factors driving the consensus call, I mean our call is not really that bullish. We're looking for 9 to 10% upside in the market off of a very good level at the end of last year. So, we think it's more of a normal year, a year of a lot of rotation.
Steve Auth: I think it's going to be a more difficult year to make money, and one where active managers are likely to do better. Because I think some of the big growth names will probably consolidate here, and we'll see some of the more cyclical tilted areas in value do better, as in a part of our call. So, your question was what's the factors driving behind it?
Linda Duessel: You're being as bullish as 3,500, I believe consensus is around 3,300-
Steve Auth: Yes.
Linda Duessel: ... for the year. So you were bullish on earnings?
Steve Auth: But that's the same crowd that were at 2,800 for last year. I mean, they just can't get over... this time last year, they were all telling us a recession was on the way, right around the corner. And that's been dead wrong, we always thought it was. There was a manufacturing pullback, but the rest of the economy's doing fine.
Steve Auth: And now, back in the fall, they began to face the prospect of a reacceleration in this economy, and they're trying to figure out how do I tell people, not only was I wrong about it, it's actually a reaccelerant. So yes.
Steve Auth: our call is based on a reacceleration in the back half. We're way above consensus on that recovery. But all the big wall street economists I talk to, if you examine their models, they'll tell me, Steve, yes, you're right, it should reaccelerate, our models indicate it. Well, why aren't you saying that? Oh, well, I mean it can't be right.
Steve Auth: But, you know, you go through it. You've got the lag impact of the Fed rate cuts. You've got the confidence that comes back into the global economy when you get trade deals with our three largest trading partners signed almost on the same day.
Steve Auth: You've got the uncertainty around the election gradually winding off as the year goes on. It might've ended last night. And then you've got the normal cyclical forces of a manufacturing sector that has been through a recession and now has to rebuild inventory. That automatically gives you an accelerant.
Steve Auth: The Boeing thing is over by then, the GM strike is over, and now I've got this new one, which is the coronavirus, there's been a shutdown. Okay, some of that's going to be lost consumption forever, but most of it is just stuff on backwater that's going to be double ordered at the back half of the year. So, there's an awful lot of factors here. And frankly if you do the math, you get to numbers north of even four on the back half.
Steve Auth: We don't even put out a number that high because everyone thinks we're crazy, but there is going to be an economic reacceleration in the back half of the year. And when you throw that in, you've got people looking at earnings into next year that are substantially higher than where they are now. And so it doesn't really become that heroic to get to 3,500.
Steve Auth: We think earnings next year, I mean, the consensus even at 195 or something, but... we're using that for now, could be higher. But even so, at 195, just even keeping the multiple the same, gets you to 3,500 you know, 18 times next year's number.
Steve Auth: So, we haven't really talked about how the real upside in this market we think could come beyond this year, when people start factoring in what should be a higher multiple, not lower.
Steve Auth: When the bear's telling me that the market is rich, I just smile. I mean, what are they talking about? We are a historically low bond yields. What we all learned in the last 12 months is that the resting place for the 10 year is permanently lower. There are too many forces at work globally to get this yield to go much higher.
Steve Auth: So, whereas a year ago we were at, I think the market was thinking probably three, three and a half was the resting point, I think now they're thinking two to two and a half, we're at 160 even.
Linda Duessel: Yes.
Steve Auth: But, you take a hundred basis points out of the discount rate on equities, and the multiple, frankly, if you do the math should be somewhere around 20.
Steve Auth: So, we think there's still more to come on just re-evaluation, but we don't, ourselves, even have that big move in the market this year.
Linda Duessel: That's a really excellent point about the yields. I can't tell you how many times I personally have read or heard that the tenure's going to 4% in six months.
Steve Auth: Yes.
Linda Duessel: And I guess that's a hard thing for people to finally admit it's not going to be that way-
Steve Auth: It's not going to happen.
Linda Duessel: ... it may be permanent or lower for longer. Well now, it is going to be a very interesting year though, it's the election season. Now assuming that Trump is re-elected, and I would love to hear your thoughts on those odds if you wish, what from a market friendly perspective do you expect out of a second Trump term?
Steve Auth: Well, on the first point, we put out one of our top five surprises for the year. I did this just to torture people frankly. But, I said the election will be over by March. And what I meant by that is that one of two things is going to happen.
Steve Auth: What we think is going to happen is, the Democratic party is going to be deadlocked, and everyone's going to start looking up at what happens now. And they're starting to do that already, and realizing, My goodness after Iowa, maybe that is what is going to happen.
Linda Duessel: You're thinking the brokered convention?
Steve Auth: Brokered convention, then what happens? Oh, the super delegates, they're still alive, they just don't vote on the first round. Their party centrics will see the politics of how that play out.
Steve Auth: But either the Democrats are going to nominate someone who cannot possibly win the Midwest, such as probably a Warren or a Sanders, or someone who maybe has a possibility. I don't think likely, but that person's going to be more of a moderate. And the market will be happy enough to know, the worst case scenario here is a moderate Democrat in the White House. It's not going to be a radical change in economic policy.
Steve Auth: I think the real upside here... and in our numbers it would be very unusual for a sitting president with this kind of economic performance... in fact, it would be unprecedented for him not to win. We've analyzed some of these close markets very closely, like Pennsylvania. It will come down to turnout, but on our numbers, we think the president's likely to win an electoral college landslide.
Steve Auth: And we don't have that in our year end forecast yet. But we do think, to answer your very first question, once the market internalizes at some point, that we're having four more years of the sort of supply side, pro-growth economic policies, you got to factor in at least a half a point a year GDP growth.
Steve Auth: What people don't fully understand, but it will be born out in time, that supply side tax reform, supply side stimulants like lower regulations have long lead times. These liberal economists coming out of places like Harvard and Princeton where I studied, I can assure you, they think about economic stimulus as, I hand out a dollar to everybody and they spend it tomorrow. It's right there, it's a sugar high as they like to call it.
Steve Auth: Supply side is different. It takes a long time. We talk to a lot of companies, Linda, as you know. When someone's after tax returns on investment just went up by 20% because of the corporate tax cuts, they're going to invest more. Now, what's the lead time for that? Well, you've got to go through a budget cycle, you've got to get things approved, things have to add margin rates, opportunities have to come available in the market. It takes more time, but it compounds on itself.
Steve Auth: So we think the full effects of the corporate tax cuts have even yet to be felt as well as the regulatory changes. And if you throw another four years of this into the market, we think the economy's likely to restore itself to a higher trend rate of growth in this too, that we've been dealing with for a long time. And that's good for earnings, and that's pretty good for stocks.
Linda Duessel: Well, excellent. We've been reading a lot about the possibility of a progressive winning the democratic nomination and what that might mean for the markets. And I wonder, I know you've said that you wouldn't be surprised to see a 5 to 10% pullback at some point in here. Do you think those concerns will be the catalyst, or what are you thinking would be?
Steve Auth: Yes. I wish I could identify it but look, people got to recognize, when a market's gone straight up like ours has, and there've been 16 rises of this magnitude, 10 to 15%, I think we're at plus 15 at this point off the October lows.
Steve Auth: Those kinds of rises without a pullback of 2 to 3%, anything worse than that, there's been 16 of them. All of them eventually end up... you expect a correction afterwards and on average, a 5 to 10% correction is what you get.
Steve Auth: In fact, the average is nine, and that's just because so many weak hands get pulled in as the market keeps going up. They don't really have a lot of conviction on the market. And then something untoward happens and they say, I knew I was right, what was I thinking? And they sell. And that's part of what a bull market entails. It entails these temporary setbacks that wash out the weak hands, instead of firmer foundations.
Steve Auth: So, we are overdue for that kind of a correction. It's not heroic I don't think, or any frankly prescience to note that, we've had a 15% rise, it'd be very natural to have 5 to 10% correction, I do expect we'll get one.
Linda Duessel: Catalyst being?
Steve Auth: I don't know, it could be this coronavirus. On early work on that was, this is probably not it. I've said that, I still think that's probably the case. If this gets a lot worse, maybe this'll cause the pullback, but it could be something else. It could be, as you mentioned, a very progressive candidate emerging as the leader on the democratic side.
Steve Auth: I'm not sure if that would be it. I think most people would do the math on that and figure, well that candidate is unlikely to win, therefore Trump. But it might scare the market enough to give us a correction.
Steve Auth: Whatever it is, it'll be something in our view that's probably not related to the long-term fundamentals. And our plan is to get even more aggressive at that point if we get there. In the meantime we're telling people stay 50% of max overweight, which is healthy, have some dry powder if there is a pullback. And you should get even a more attractive entry point at some point, but if not, you're still overweight equities. So that's how we're sitting right here today.
Linda Duessel: Mm-hmm (affirmative). And a 5 to 10% pullback is a feature of an average year in the stock market, right? And a good healthy thing for the market.
Steve Auth: Yes, absolutely, it's a good thing.
Steve Auth: Yes, my theme for the market this year is be not afraid.
Linda Duessel: Yes.
Steve Auth: You got a conviction in what you want. There's going to be some scary moments. Those would be the ones to hold on and have some conviction.
Linda Duessel: Steve, I'd like to squeeze one last question in if I may?
Steve Auth: Sure, Linda.
Linda Duessel: This correction that we may get at any point in time, do you think that algorithmic trading could exacerbate such a correction?
Steve Auth: Yes, it's possible. We watch the algos now. I mean, we've studied them carefully, and you can see their footprints in the market around certain types of events, and, yes, they could feed on themselves. The heavy amount of passive money out there could feed on it, who knows? It might even extend to something... I mean, what you're implying is, what you'd normally expect could be a little worse wouldn't surprise me.
Linda Duessel: Okay.
Linda Duessel: Great. Thank you Steve, and thank you to our listeners. We look forward to you joining us again on the Federated Hermes, Hear and Now podcast.
Disclosure: Views are as of February 5th, 2020 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Federated Global Investment Management Corp. 20-10013 (2/20).