Monday was six years to the day that the market bottomed and then started to claw its way back from the mortgage disaster related sell-off, and investors are now at a crossroads. What to do now is becoming one of the most frequently touted subjects at almost all the firms we cover on Wall Street, and with good reason. The S&P 500 is trading right around 16 times earnings, which is historically high. Double-digit gains cannot last forever, so what is in store going forward?
A new report from Savita Subramanian and her top-flight equity strategy team from Merrill Lynch takes a very long look at the S&P 500 and current market conditions. While hardly pounding the proverbial table and screaming buy, the report makes a very solid case that investors should remain in the stock market and stay long the S&P 500.
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Here are Merrill Lynch’s 10 reasons to stay long the S&P 500.
- Sentiment is far from euphoric. In fact, sentiment is at bearish extremes, with Wall Street strategist recommending just a 52% stock allocation. In the past, the S&P 500 has gone up over the next 12 months an astounding 98% of the time with bearishness at that level.
- Fund managers have almost 5% in cash. Mountains of money are still waiting on the sidelines.
- Equities have seen much less cash since 2009 than bonds, $500 billion versus $900 billion. As rates drift higher, some of that bond money should rotate out.
- The S&P 500 is 60% less levered that at prior market highs. Leverage can exacerbate selling and make a normal correction turn into a route. The market has leverage ratios just above a third of the levels in 2000 and 2007.
- U.S. corporations also have mountains of cash. Plus, they are generating more free cash flow every year.
- Almost half of the S&P 500 stocks pay a dividend higher than the 10-year Treasury. In addition, the S&P 500 payout ratio sits at century lows. With rates not going higher fast, the dividend-paying stocks remain a solid investment idea.
- Despite the higher than normal current price to earnings concerns, other metrics like free cash flow and price to normalized earnings still look attractive to the Merrill Lynch team.
- The United States is the greatest global innovator, and research and development (R&D) to gross domestic product has been rising. More innovation means more goods and services. In addition, with U.S. companies spending more than any other country on R&D, including China, and they typically will outperform.
- While U.S. stocks trade at a 10% premium to global stocks, the analyst point out that with higher return on equity, lower beta and many higher ranked stocks, that premium is warranted.
- Lower oil prices and looming global quantitative easing can stimulate additional growth and reduce the risk of a global slowdown. The analysts believe that should offset the near-term hit than energy earnings are and will be taking.
One of the major problems over the years with Wall Street strategists and analysts is that they have been tended to be on many occasions wishy-washy and not taken a stand. The Merrill Lynch team at least has the guts to say they think the time is still good to own stocks. They also caution that while near-term risks and volatility are present, the longer an investor’s time horizon and holding period, the better the chances are for success. That has proven over the years to be the gospel in stock investing, and will remain so going forward.
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