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There’s a big disappointment on the way for markets, says strategist

Balloon about to pop
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Balloon about to pop

Equity market investors are primed to be sorely disappointed as stock prices have now raced far ahead of realities, warned an investment strategist on Monday.

"We think there's big disappointment on the way for these markets," cautioned Ian Harnett, co-founder and chief investment strategist at Absolute Strategy Research, noting that companies have already factored in an assumption that the tax cuts proposed by President Donald Trump will be enacted as soon as this year.

"Both households and corporates are effectively spending those tax cuts already, mentally they're building those in," he claimed, highlighting that the recent attention devoted to reforming former President Barack Obama's healthcare plans by Congress is actually distracting from and slowing down the pace of tax reform, thereby raising the prospect of earnings forecasts being slashed from double digits to around 5 to 7 percent.

Speaking on CNBC's Street Signs, Harnett also warned that rising protectionism could have negative ramifications for global corporates.

"These companies have become fine-tuned to the new global environment they had. They were accessing the lowest cost of production, they were accessing the lowest cost of capital, they were accessing the lowest cost of finance, wherever they could find it globally. As you go to protectionism that is just going to raise prices and squeeze profits," he explained.

Turning to the economy, Harnett cautioned that the signals were not as robust as many believe.

"We're seeing a lot of hope. The surprises are on the soft data, the survey data those are really, really strong. The hard data is actually really quite weak," he noted, adding that inflationary pressures are also beginning to wane, as reflected in some core government bond yields retreating.

"We're not seeing the big drive for higher real yields which would give you a strong sense that global growth was reaccelerating. Just look at what's been happening since December - it's actually been the defensive stocks that have outperformed not the cyclical stocks," argued the strategist.

All of this analysis has led Harnett and his colleagues to conclude that a big recalibration should theoretically lie ahead, wherein equities should beat bonds by around 200 to 300 percent over the next ten years.

However, Harnett noted, "the trouble is you cannot start that process from a cyclically adjusted P/E (price-to-earnings) multiple of 27x."

Drawing on historical parallels, Harnett pointed out that back in the early 1950s, bond yields were around the same level but equity valuations were only trading on an approximately 10x cyclically adjusted P/E multiple.

Harnett concluded by advising there will be better opportunities at later points during the Trump administration to buy into equities and told would-be investors to ponder one key question.

"All you have to ask is 'do you think unemployment will be higher or lower at the end of the Trump administration?' And if it's higher then equities actually underperform bonds," he suggested.

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