Don't Fear the Selloff: After April Showers, Market Could Bounce Back
The stock market is likely to see its typical, seasonal pullback in the second quarter after the first quarter's sharp gains, but unlike previous years, more bullish Wall Street strategists expect a significantly higher end-of-year finale.
"Anyone who's looking for the S&P 500 to end the year at 1,650 to 1,700 is looking for a 17-percent appreciation–excluding the late 1990s and the two recovery years of 2003 and 2009, you'd have to go back to 1991 to see that kind of bounce," said Dan Greenhaus, chief global strategist at BTIG, who himself has a year-end target of 1,625. "There's an incredible sense that things are starting to come together and things that have been supportive of the recovery all remain in place."
Greenhaus noted that the average annual S&P 500 gain is about 7 percent.
Major averages have been on a tear in the first quarter, thanks largely to better-than-expected earnings, further evidence of a healing economy, and ongoing support from the Federal Reserve. The Dow pierced through its all-time high at the beginning of March and is on track for its best first quarter gain in 15 years. The S&P has soared about 10 percent this quarter and on the final day of the quarter, it recovered its record closing high of 1,565, set on Oct. 9, 2007.
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Analysts have jumped aboard the bullish momentum. Just in the last two weeks, major banks have raised their year-end price targets for the S&P. Goldman Sachs lifted its year-end target to 1,625 from 1,575, adding that financials, industrials and materials should outperform the broader market.
Similarly, Deutsche Bank increased its forecast to 1,625 from 1,600. Even Morgan Stanley, whose strategist Adam Parker has been bearish, boosted its target to 1,600 from 1,434, citing the improving U.S. economic growth and liquidity from the Federal Reserve.
Most recently, S&P Capital IQ sharply hiked its 12-month target to 1,670 from the 1,550 level established in November, citing improvement in global economic growth.
Defensive sectors have boosted the market, with health care and consumer staples surging more than 13 percent each in the first quarter.
"If the market is going to be up considerably, people usually think the cyclical sectors would lead it. But that hasn't been the case this year–materials and techs have been the worst performers so far," noted Greenhaus. "There are still fundamental reasons to favor health care and consumer staples…and even with energy and industrials in the middle of the sector pack, they just need to catch up modestly to boost the market."
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In the last three years, strong market run-ups in the first quarter have led to pullbacks of between 10 to 20 percent during the first few weeks of the second quarter. And ahead of the second quarter this year, the debate continues over whether equities will see a consolidation.
"It looks like the rally's gotten tired and we're due for a pullback for stocks. And while we may not see the huge pullback like in the past years, a smaller decline of about 5 to 10 percent is what we're expecting," said Jeff Kleintop, chief market strategist for LPL Financial. "But we'll see a bounce after that, so individual investors can use this market to their advantage and look to buy on the dips."
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Some analysts point to slow earnings growth as a possible catalyst for the pullback.
"Absent the unpinning of the market by the continued liquidity coming from the Fed, we are going to be focusing on first-quarter earnings," said Quincy Krosby, market strategist at Prudential Financial. "Worries over the sequester and Europe kept companies from spending—we want to see if they've turned the corner and whether demand is picking up."
Earnings growth expectations for the first quarter are at a modest 1.5 percent, according to the latest data from Thomson Reuters. So far, a little over 100 companies on the S&P 500 have provided negative earnings guidance compared to 23 positive pre-announcements for the first-quarter. Still, earnings growth is forecast at 9.2 percent for the year.
"Earnings expectations have not risen as much as in prior years, which may limit the disappointment," wrote Kleintop. "It is too early to say whether [the earnings revision] indicator is flashing a warning sign."
Also keeping investors nervous are negative headlines from Europe. In addition to the jitters over the Cyprus bailout, investors added Italy's economic and political concerns to their list of worries as the nation faced ongoing political deadlock.
"In the short-term, we've had a big move since November and if investors are going to be nervous, Europe's going to be an excuse," said Thomas Lee, chief U.S. equity strategist at JPMorgan. "But at the end of the day, I don't think this is a big enough threat to say the bull market's over and global recession's starting because there's another financial crisis."
Lee has a year-end target of 1,580 on the S&P 500.
"The big picture still points to a major secular bull market being underway, with at least another four years left, led by durable goods," he said.
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