Ditch the doom, the election will take the market higher

Gloom seems to dominate much of the investment world these days. Banks are forecasting a drought in growth; the Fed is dithering on raising rates; short interest on stocks is sky high; many analysts say equities are fully valued if not overvalued.

And the current earnings season? Analysts predict certain sectors to report results somewhere between dismal and a disaster – after lowering estimates, sometimes because of downward guidance.

Democratic U.S. presidential candidate Hillary Clinton takes the stage at her five state primary night rally in Philadelphia, Pennsylvania, U.S., April 26, 2016.
Dominick Reuter | Reuters
Democratic U.S. presidential candidate Hillary Clinton takes the stage at her five state primary night rally in Philadelphia, Pennsylvania, U.S., April 26, 2016.

Maybe the pessimism stems from a 24/7 news cycle, or the hard-to-shake memories of the recent Great Recession, or an admittedly long-in-the-tooth bull market, now creaking into its eighth year.

Regardless, the high level of negativity is unwarranted. In fact, if you believe contrarians, it's a positive, as market shocks to the downside usually occur during periods of ebullience, not fear. And don't forget the average return for the stock market during presidential election years is 6 percent.

Of course, more rational reasons exist to adopt a more sanguine, perhaps even optimistic, view of the economy and the equity markets for the next eight-and-half months.

Although the market, I do believe, is fairly valued, I expect it to move upward between now and the end of the year to somewhere between 2125 and 2150 on the S&P 500. (This is only a couple of percentage points higher than the close on Friday, so don't get too excited.)

Future earnings pick-up should be a driver. The dollar has weakened, and that will be positive for earnings as we move through the year; we expect to see earnings accelerate from a weak first quarter. (Note that since the recovery began in 2009, most earnings for the first quarter have been soft compared to subsequent quarters that year.) And the energy sector will be a smaller drag given the move up in oil prices.

But what if, as some economists believe, GDP for the first quarter comes on April 28th just a hair below zero? I wouldn't be alarmed. If stocks swoon, I'd look at it as a buying opportunity. We'll see GDP improvement in the third and fourth quarters. I would expect some improvement in the second quarter, too, thus avoiding two consecutive quarters of negative growth, which is what some technically define as a recession.

That's not to say everything will be smooth sailing in the near term. The market will remain sensitive, and we'll likely see some higher volatility; the 24/7 news cycle will carry some bad headlines that will make an impact. That is to be expected, however, as when a solid earnings underpinning doesn't exist, stocks are vulnerable to fluctuations.

Financials, in particular, may be in for an extension of their rocky ride, especially if the Fed doesn't raise rates at a pace the market expects. Extraordinarily low rates — the yield on 10-year Treasury notes fell from 2.25 percent in January to 1.70 percent earlier this month, despite the Fed's December rate hike — are squeezing bank net interest margins and, as a result, profits.

Potential calamities always exist that could derail our cautiously optimistic outlook, globally and in the U.S. I'm always watching for unforeseen economic/political events affecting China and other emerging markets. The United Kingdom leaving the European Union is making news; a so-called Brexit would likely lead to a stronger dollar and pressure multinationals' exports and earnings. If oil prices plummeted from their new newfound stabilization around $40 per barrel, it could take stocks down with it.

These are wild cards, though; we don't see a meaningful probability that they will cause a prolonged drop in the markets. And if we do see that the market gets hit, we'd look at it, again, as a short-term event and consider it a buying opportunity for stocks.

Bottom line: The U.S. economy is moving forward. Heightened volatility offers opportunity for longer-term, disciplined investors.

My message to investors: Sit tight.

Commentary by Debra Silversmith, the chief investment officer of First Western Trust.

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