The most accurate U.S. equity forecasters say December is the wrong month to abandon stocks that by some measures are rising faster than ever before.
Gains that have lifted the S&P 500 Index above its five-day moving average for 29 consecutive days, a display of momentum unmatched in history, will last into the new year, according to Tom Lee, the managing partner of Fundstrat Global Advisors. Jonathan Golub, the chief U.S. market strategist at RBC Capital Markets, says earnings growth is too strong for rising valuations to derail the advance.
The S&P 500 has climbed for six straight years in the month of December, posting an average return of 2.2%. While price-earnings ratios exceed levels prior to the crash of 2008, the stock market is likely to keep rising thanks to falling oil prices and accelerating economic growth, said Messrs. Golub and Lee, whose predictions at the start of 2014 proved the most prescient among 21 strategists tracked by Bloomberg.
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“Stocks get a lot of seasonal lift into the end of the year because people position for the next year,” said Mr. Lee, whose 2014 estimate for the S&P 500 was 2,075, or 0.4% above its level now. “The strength of markets from October was a V-shaped bounce off the bottom. I don't think that means we don't have enough fuel to rally into the end of the year.”
STEEP GAINS
The S&P 500 has surged 11% from a six-month low on Oct. 15, erasing a 26-day plunge that wiped out $2 trillion of share values and sending the gauge to record highs 12 times in November. Starting Oct. 17, gains in the index have been so steep that it closed below the average level of the previous five days only once, the longest such stretch on record, data compiled by Bloomberg show.
Futures on the S&P 500 expiring this month dropped 0.4% at 9:53 a.m. in London.
Relative to profits in the last 12 months, the rally has pushed the S&P 500 to a price-earnings ratio of 18.3, surpassing its highest levels in 2007 and 2008, when American equities were starting a 57% plunge. The benchmark measure is trading about 2 percentage points above its average multiple for the last 10 years, a sign to Mr. Golub that enthusiasm for stocks isn't too high to prevent future gains.
“What we've really had is a 5 1/2-year-long healing process,” said Mr. Golub, who like Mr. Lee predicted the S&P 500 would reach 2,075. “The question is if we're done healing, if this is behind us, and the answer is an unequivocal 'no.' Even though multiples are modestly above long-term averages, they should progress higher from here as the recovery continues.”
SMALL CAPS
Reports last week showed the U.S. economy expanded more than previously forecast and consumer confidence climbed to its highest level since 2007. Small-cap shares, which are more dependent on domestic growth, have rallied 12% since their low on Oct. 13, while technology companies in the Nasdaq Composite Index have jumped 14%. Those beat the S&P 500, which advanced 10% in the period, as energy producers limited its advance after OPEC kept its oil-production target unchanged despite a supply glut.
Momentum alone is reason to own stocks because each time the index rises, it means more fund managers fall behind and need to buy so they can catch up, a phenomenon sometimes referred to as chasing beta, according to Lee.
About 75% of mutual funds are behind their benchmarks this year, according to data from Mr. Lee's Fundstrat as of Nov. 11. Investors of mid-cap stocks and smaller companies have fared even worse, with 91% and 87% trailing their benchmarks, respectively, Lee wrote in a Nov. 14 note.
Underperformance becomes harder for mutual funds to erase as the year progresses, helping explain why December has been such a positive month for stock investors during the bull market that began in March 2009, said Michael Purves, the chief global strategist at Weeden & Co.
“December can be a very, very strong month, just look at last year,” said Mr. Purves, whose call for the S&P 500 at 2,100 was among the most accurate. “A lot of managers, whether they're long-only or hedge fund, are noticeably below benchmark indices. For them not to be grabbing for beta into year-end is unrealistic. It almost becomes a self-fulfilling prophesy.”
Americans have more than $11 trillion of cash generating little or no interest in savings accounts, money-market mutual funds and retirement plans, according to JPMorgan Asset Management. That's money that will sustain the bull market, said Kerry Craig, global market strategist for the firm in London.
ABSOLUTELY NONSENSICAL
“Holding cash is absolutely nonsensical in this environment,” Mr. Craig said in a phone interview. “Rates are still very low,” he said. “That is going to make investors who have been sitting on the sidelines and thinking they've missed out on the rally to finally put more money into equities.”
While the Federal Reserve has ended its asset-buying program, central banks from Asia to Europe are adding stimulus. The People's Bank of China cut benchmark interest rates for the first time since 2012 and European Central Bank President Mario Draghi said the ECB will widen its asset-purchase program if necessary. The Bank of Japan expanded its unprecedented monetary easing in October.
Savita Subramanian, a strategist at Bank of America Corp. in New York, is less bullish.
The U.S. stock rally since October went “too far too fast,” according to Ms. Subramanian, who predicted in January the S&P 500 would rise to 2,000 at the end of the year, or 3.3% below last week's close. The brokerage won't revise its year-end estimate, she said.
One of the most popular measures of market momentum is flashing a bearish sign. Since Nov. 20, the S&P 500's relative strength index has been above 70, a level some traders say shows gains are getting too fast to maintain. The RSI, which compares the size of recent gains to recent losses, was below 30 on Oct. 16, signaling the U.S. equities gauge was oversold.
“The market rallying on hope around Japan and Europe seems frothy,” Ms. Subramanian said. “These QE-driven rallies are a bit questionable. Every time we got a round of QE, we saw low-quality, risky stocks doing well. Given how far the U.S. has come and that we're done with QE, that we're going to be excited about it from Europe and Japan is questionable.”
Ms. Subramanian doesn't expect the S&P 500 to have a “meaningful” sell-off this month because there is money waiting to be put to use as investors' equity allocations are still lagging behind other asset classes, she said.
NOT ENOUGH
While money entering stock funds has kept pace with bond funds in 2014, it hasn't been enough to reverse the $1.14 trillion that has gone into fixed-income portfolios since 2007, according to data from Investment Company Institute. Investors pulled about $255 billion from equity products in the same period, ICI data show.
The one place traders are confident about is the U.S., with investments in stock funds at a five-year high, according to a report from Barclays Plc last month.
Large speculators, whipsawed by the rebound in October, have boosted their bullish bets and are now net-long U.S. shares, according to data compiled by Bloomberg and the Commodity Futures Trading Commission.
The October selloff lured money from individual investors. They sent more than $200 million to U.S. equity mutual funds that month, following six months of redemptions, according to data from ICI.
“Even in the drawdown, we didn't change our portfolios at all,” said William Low, a fund manager at Nikko Asset Management Co. in Edinburgh. His firm oversaw 17.5 trillion yen ($147 billion) as of Sept. 30. “We stuck through it. It's the economic backdrop that's supportive, just as companies offer more profitability and growth. That's where your returns will come from.”
