As the Dow Jones Industrial Average inches toward the 20,000-point milestone, most Wall Street strategists think it will move at least a little bit higher. But the extent — and the shape — of the coming gains remain in dispute.
The big stock indices, like the Dow and , have surged since the election, reflecting rising confidence in surveys of audiences as diverse as consumers and home builders. The promised stimulus of federal spending increases, especially on infrastructure, and tax cuts seems to many investors to promise faster growth next year, even as incoming fourth-quarter data points to a dip from 3.2 percent annualized growth during the third quarter.
Many forecasts call for the S&P 500 to reach only 2,300 to 2,350 by the end of 2017, even though corporate earnings are set to rise as much as 12 percent, led by a quadrupling of energy-sector profits that were clobbered in early 2016 by cheap crude-oil prices. In that argument, stocks already reflect the earnings gains and have only about 1 percent to 4 percent more potential for short-term gains, according to market analysts.
Predictions for which sectors may lead the way show some of the divides between optimism and realism roiling the market since the election: Strategists are divided over the wisdom of rallies in financial and energy stocks especially, with skeptics saying banks and asset managers are now overpriced and may not get as much of a bump from deregulation as bulls think, and that oil-exporting nations will probably break their recent agreement to limit production and prop up prices.
A bonus wild card is the erratic nature of President-elect Trump, known to hop on Twitter and begin bashing the likes of Boeing and Lockheed Martin over light criticism, let alone the wrath an errant restaurant review might incur.
"I'm a bull with a lowercase b," said CFRA chief investment strategist Sam Stovall, noting that traditionally, earnings gains turn out to be much lower than predicted before a year begins. "History says that if we expect 12 percent growth, we'll get six and a half. If Trump accelerates the economy, maybe we'll get the 12."
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As Stovall suggests, the market's new milestone and post-election surge are on a collision course with the fact that most banks' economic forecasts have barely budged since the election. For all the rhetoric about growth, Bank of America Merrill Lynch's post-election forecast for expansion in U.S. gross domestic product stayed at 1.9 percent, with slower growth in early 2017 and some acceleration late in the year as Trump's policies get implemented. The Federal Reserve marked up the mean forecast of its Open Market Committee members by only 0.1 point, to a still-paltry 2.1 percent.
Indeed, Goldman Sachs warns that investors may get ahead of themselves in early 2017 generally, with the S&P hitting 2,400, then see stocks give back some gains when a deficit-conscious Congress scales back the president-elect's corporate tax-cut plan.
"Sector investing in 2017 should be all about identifying where growth has the best chance of being stimulated, whilst simultaneously overweighting fundamentals vs. rhetoric," BMO chief investment strategist Brian Belski said.
That's easier said than done, but some sectors elicit broad agreement. Materials stocks are a good bet to bounce back from years of depressed commodity prices, though Bank of America Merrill Lynch strategist Savita Subramanian notes that those stocks are more exposed to China's economy than other industries.
BMO, CFRA and Merrill all rate tech stocks as a group as market performers, meaning they will do about as well as the broader market. And there is skepticism about real estate and utility stocks, like Exelon and Southern Co., whose appeal will wane as rising bond yields provide less-risky competition for these often hefty dividend-yield stocks.
Both real estate and utilities flourished as dividend-rich alternatives to a bond market that has been paying near-zero interest rates, and they will become less attractive as bonds regain some allure for income investors. Real estate investment trusts, like Washington REIT and Equity Residential, that are already tax-free because they pass their earnings through to unit holders won't benefit much from Trump's vow to cut corporate income taxes.
Here's how different strategists and banks are looking at the more controversial sectors among the 11 industry groups in the S&P 500.
The bulls say widening interest-rate spreads between loans and deposits will boost income in banks' core businesses, while full or partial repeal of the 2010 Dodd-Frank financial regulation law — or the new fiduciary rule requiring asset managers to put clients' financial interests ahead of their own — will bring back dormant businesses or cut down red tape. Skeptics say rates are likely to stay low for longer than bulls think and that the surge in shares since the election overstates any gains the companies are likely to get from deregulation soon.
BMO says investors should overweight financial stocks despite their rally since the election, thanks to reversal of what Belski calls overregulation, as well as the expected climb in interest rates and widening of spreads between deposit costs and income from loans and fees.
CFRA rates them as "equal weight," thanks to their newly boosted valuations, and Morgan Stanley suggests some financials, especially asset managers like BlackRock and T. Rowe Price, have risen too quickly as speculators bet that deregulation will make a bigger, faster difference than it actually will. With T. Rowe shares up 21 percent, the same as Prudential Financial's, and industry leader BlackRock up 12 percent since the election, CFRA analysts think any more near-term gains are speculative.
BMO calls energy an equal-weight sector, while CFRA recommends underweighting energy stocks. CFRA thinks oil prices will drop and head back to $50 a barrel from the recent levels around $55. This will happen as major producers cheat on production quotas set up this month by the Organization of Petroleum Exporting Countries, or OPEC.
BMO says the smart hedge is to bet on cash-rich producers like Exxon Mobil and on services companies that will bounce back if drilling does, even if the price per barrel falls slightly short of forecasts.
BMO's Belski says investors should overweight health-care stocks, which he says will benefit from Trump's unwillingness to have Medicare negotiate over drug prices, and from what he called a "mulligan" on the Affordable Care Act. Congressional Republicans want to repeal the Obamacare law and replace it with some smaller yet unidentified substitute. Besides, the stocks are cheap, he argues.
That logic made little impression on CFRA analyst Jeffrey Loo, whose firm calls for underweighting health care, especially hospital companies like HCA Healthcare and Tenet Healthcare and insurers who focus on the Medicaid market, like Molina Healthcare. Both have benefited from the law's expansion of federal Medicaid funding to cover more working-class families, and the individual mandate and subsidies that are convincing more middle-class workers to get coverage.
"We don't see any clear winner if the individual mandate and Medicaid expansion are eliminated," Loo said. "The potential of losing upwards of 20–22 million insured patients will likely result in lower health-care utilization, resulting in lower sales across the sector.''
Merrill analysts suggest that companies set to benefit from Trump's infrastructure-pending push may be done with their rally, especially since the firm expects Congress to spend less than the $1 trillion over 10 years the president-elect has floated. Most firms agree that companies like Lockheed Martin will benefit from higher defense spending, but Merrill says Boeing may see its commercial business slow down more than its defense units can make up for.
The defense stocks highlight a point both Merrill and Goldman made in their 2017 forecasts: No one really knows what Trump will do. If the president-elect is the growth-seeker who cuts taxes and spends more, investors will see one kind of market. If he's the combative protectionist who slaps fat tariffs on Mexican cars and Chinese-made cellphones, there will be another.
The outcome will be up in the air until Trump makes his detailed proposals — and until Congress decides how much of the new president's agenda to buy into.
— By Tim Mullaney, special to CNBC.com