Market Extra: Think U.S. stocks will keep rallying into 2018? Not so fast, says SocGen

November 23
19:04 2017

Investors hoping this bull market will get juiced even further in 2018 may be setting themselves up for disappointment.

That’s according to strategists at Société Générale, who released their equity outlook for the coming year on Thursday.

“We expect stretched valuations and rising bond yields to limit equity index performances in 2018 and the prospect of a U.S. economic slowdown in 2020 to further cramp returns in 2019,” said a team led by Roland Kaloyan, head of European equity strategy.

They describe upside potential for the S&P 500 index SPX, -0.08%  , which has enjoyed a 16% run higher this year so far, as “limited,” saying a rebound for growth and inflation has already been priced in.

They predict the index will finish next year at around 2,500, which would mean little or no progress against current levels in a year that has delivered more than 50 record closes.

Read: Goldman Sachs says ‘rational exuberance’ to drive stock market in 2018

Noting one headwind to a move higher, Kaloyan and the team said U.S. equities haven’t looked like a bargain for a while.

“Indeed, on all the main valuation metrics, U.S. equities are trading above their long-term average and at a level only seen during the dot-com bubble,” they said.

In addition, they noted that at 12%, the expected 12-month growth for earnings is below the 20-year average of 14%.

The Société Générale team said any increase in bond yields will “push the equity market further into expensive territory relative to bonds.” If the yield on the 10-year U.S. Treasury bond TMUBMUSD10Y, +0.00%  hits 2.7% by the end of 2018, that could cause stocks to stumble, they said.

Read: Stock market could tumble 15% if 10-year Treasury yield crosses this line, says SocGen

And there’s yet another problem for U.S. stocks, the strategists said — the much-anticipated U.S. tax-cut plan may prove less of a fillip than expected.

The hope has been that a decrease in the U.S. corporate tax rate from 35% to 20% — as proposed in the tax bill backed by President Donald Trump — will help drive more earnings growth.

But the SocGen team points out that only half the gain in the S&P 500 since Trump’s election has come from higher earnings. The rest is from price/earnings growth, they say.

They note the top 10 contributors to the bull run have seen their P/E ratios expand over the last 12 months. Only Apple Inc. AAPL, +1.05%  , J.P. Morgan Chase & Co. JPM, -0.29%   and Bank of America Corp. BAC, -0.26%  have 12-month P/E ratios that are below the market average of 18 times.

And except for Inc. AMZN, +1.46%  , all of those top S&P 500 performers pay corporate taxes at a rate below the U.S. federal 35%, once other factors are taken into account. Five pay below 20%.

Equities overseas

Outside Wall Street, Kaloyan and the team said there isn’t “much meat on the bone” for European stocks SXXP, -0.08%  . The economic recovery story there — a factor that has driven investors towards the region — is now well known. They said a better economy will boost the euro EURUSD, +0.2030%  , which could then be a headwind for profit growth.

Read: Safer and cheaper than Europe—why it’s time to jump into Swiss stocks

Drilling down, they prefer French PX1, +0.42%  and German DAX, -0.37%  stocks over Italy I945, -0.01%  and Spain’s IBEX, +0.44%  equity markets.

“We also recommend staying away from the U.K., as Brexit negotiations are accelerating and several scenarios are possible: Only a soft Brexit would be supportive for the FTSE 100 UKX, -0.15%  ,” said the strategists.

As for Asian equities, the strategists don’t expect the strong returns in China seen over the last 12 months to repeat themselves, leaving them neutral on Chinese stocks SHCOMP, -2.29%  . They’re overweight on NIK, +0.48%   Korean SEU, -0.13%  and southeast Asian markets, but underweight India 1, +0.08%  and Taiwan Y9999, +0.30%  .

Read: Chinese stocks fall sharply, hit by regulatory concerns

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