Is the Fed on the verge of sparking a stock-market ‘melt-up’?


The Federal Reserve is almost certain to cut rates at the end of July — but don’t expect a melt-up in equities, usually marked by a powerful rally followed by a substantial selloff, says Mark Haefele, global chief investment officer at UBS Global Wealth Management.

In a research note dated July 15, Haefele says stock-market bulls are enjoying a so-called Goldilocks environment, where the market will see benchmark borrowing costs lowered even though the economy remains relatively healthy, albeit slowing in some parts.

At the conclusion of the Federal Open Market Committee’s two-day gathering July 31, Wall Street is betting a quarter-of-a-percentage-point rate reduction of the federal funds rates which currently stand at a range of 2.25%-2.50% at the conclusion of the Federal Open Market Committee’s two-day gathering July 31.

Read: Good data or not, UBS still expects a half-point rate cut

Haefele says there are some key reasons that investors would likely remain hesitant to take stocks to record heights in a frenzied rally: high stock valuations and a likely dim picture from second-quarter results.

Read: Stock-market ‘melt-up’? These ingredients are missing, says Morgan Stanley

“While we expect modest upside for stocks in our base case, valuations and corporate fundamentals don’t point to a ‘melt-up’. Earnings growth remains subdued and multiples have only modest scope for further expansion,” the UBS analyst wrote.

On the earnings front, here’s how the UBS analysts explains his thinking:

Corporate earnings growth remains subdued – we expect aggregate S&P 500 earnings per share (EPS) growth of 1%–2% in 2Q. Corporate profit growth has stagnated this year due to several factors: difficult comparisons versus the year-ago period, which was boosted by tax cuts; slower economic growth in the US as fiscal stimulus fades; weaker overseas economic activity; higher tariffs; and weaker results for some of the largest US companies. We only expect earnings growth to pick up again in 2020.

Currently aggregate price to earnings, or P/Es, for the S&P 500 index

SPX, +0.02%

stand at 19.39, over the past year, marking the loftiest level for the market since around November of 2018, according to FactSet data.

Haefele says stock P/Es, a popular way of measuring stock-market values, are also rich on a historic basis: “Multiples have only modest scope for further expansion. The rise in the S&P 500 year-to-date has been driven almost entirely by higher valuations,” he wrote. “The forward P/E on 31 December 2018 was only 14.5x, but is now 16.9x, marginally above the five-year average of 16.5x.”

To be sure, the analyst isn’t predicting a melt down in stocks either, but says that the tenuous state of the market lends itself to maintaining exposures to stocks, but with the caveat that second-half returns will be more modest than the market has thus far seen.

In the first half of 2019, the S&P 500 gained 17.4%, the Dow Jones Industrial Average

DJIA, +0.10%

rose 14%, the Nasdaq Composite Index

COMP, +0.17%

gained 21% and the small-capitalization focused Russell 2000 index

RUT, -0.52%

advanced 16.2%.

“Over our six- to 12-month tactical time horizon we continue to overweight equities with a regionally selective approach. To increase our equity exposure further we would want to see signs of renewed monetary policy easing translating into a pick-up in economic and earnings growth expectations,” he wrote.

Source : MTV