Stock market outlook: 3 events, scenarios that will shape the future - Josh Loe

Stock market outlook: 3 events, scenarios that will shape the future

With so many catalysts swirling around the stock market, it can be difficult to know what to do. For many investors, varying signals and expert opinions only add to confusion around the best way forward.

But Bank of America Merrill Lynch has a different perspective. Strategists at the firm say the equity landscape is actually quite simple — as long as investors properly understand the three big drivers at the heart of the market.

Savita Subramanian, BAML’s head of US equity and quantitative strategy, recently went deep on these three core catalysts. Not only did she discuss what was at stake, she also outlined the scenarios associated with each.

In doing so, Subramanian concluded that all three drivers are, in fact, quite binary in nature.

“Dual-outcome factors abound,” Subramanian wrote in a recent client note. “These issues have already driven dispersion across asset classes, sectors and stocks.”

The three catalysts are presented in detail below. Each section lays out the straightforward scenarios BAML says will determine the fate of the stock market in 2019 and beyond. All quotes attributable to Subramanian.

1) China trade: Deal or no deal?

Before we get into the scenarios, it’s important to understand just how much is riding on a resolution to the US-China trade war.

According to the survey of financial advisors summarized in the chart below, the trade war viewed as the most ominous risk to stocks going forward. With that in mind, it can be concluded that a successful deal will be the biggest potential driver of future gains.

Bank of America Merrill Lynch

Right now, BAML says a partial deal is already priced into the stock market following recent headlines out of Washington that have made a resolution look more likely.

Scenario 1 — A real deal: “We would expect 5-10% upside for US stocks, with direct and indirect benefits to EPS (unleashed spending) could benefit global cyclicals.”

Scenario 2 — A partial deal: “We would expect a “sell the news” knee-jerk reaction, and under a full-blown trade war could erase most, if not all, of its YTD gains.”

Scenario 3 — A full-blown trade war: “5% to 10% downside risk … Additional tariffs directly hit S&P 500 EPS by 1 to 2 ppt … P/E compression on uncertainty overhang.”

2) The Fed’s next move: Hike rates or cut them?

BAML points out that, as of right now, futures are pricing in zero rate hikes for the remainder of 2019, followed by a rate cut in 2020. However, BAML itself expects the Fed’s next move to be an increase.

Scenario 1 — The Fed is hawkish going forward: “If Fed Chair Powell’s tone is hawkish enough for the market to price in a tightening in 2019, the S&P 500 could see a knee-jerk pullback. Sectors and industries likely to sell off under that scenario are: consumer plays that benefit from low rates, and easy credit and benign inflation, as well as high dividend yield sectors.”

Scenario 2 — The Fed is dovish going forward: BAML finds that the following 10 stocks have outperformed the most during past instances of Fed dovishness: Arther J. Gallagher (AJG), Lennar (LEN), PVH (PVH), Progressive (PGR), Baxter International (BAX), Altria Group (MO), Amgen (AMGN), Atmos Energy (ATO), UDR (UDR), and Mondelez (MDLZ).

Here are the results from a recent BAML survey on the Fed, to give you an idea where different expectations stack up.

Bank of America Merrill Lynch

3) Brexit: Hard or soft?

A recent BAML survey found that 29% of respondents had no clue what to expect with respect to Brexit. Allow Subramanian and her colleagues to shed some light.

Scenario 1 — Hard Brexit: “A hard Brexit / a no withdrawal deal would represent a short sharp downside shock to European, US and global stocks in the 5-10% range.”

Scenario 2 — Soft Brexit: “BofAML economists’ base case is a ‘softer’ withdrawal deal, representing a long term negative rather than a knee-jerk sell-off. With the S&P 500’s ~2% UK sales exposure, the impact is likely to be through 2nd order effects like GDP, USD, oil, etc.”

As with the Fed situation above, BAML conducted a survey of what people consider to be the most likely Brexit outcome.

Bank of America Merrill Lynch

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