Why Stifel Strategist Sees Little 2018 Upside and a Potential 2019 Bear Market

The bull market has run for over nine years, and some on Wall Street think that the long run may be coming close to an end, and with good reason. While no true sword of Damocles hangs over the market right now, there are a plethora of items in the financial stew that could cause some significant selling, especially if the technology sector, which has led for so long, does a nosedive.

A new Stifel report from the firm’s head of Institutional Equity Strategy and Chief Equity Strategist, Barry Bannister, makes the case that the long run is indeed coming to an end, and the firm is advising clients that it is time to move to a more defensive portfolio posture. This is big because Bannister is hardly some uber-bear that constantly has warned that the sky is falling. He is, however, a pragmatic equity strategist that can see the proverbial forest through the trees. The report noted this:

Our models for the S&P 500 point to minimal price upside in 2018 and a bear market (-20%) in the coming year. What matters for investors is that any decline is likely to be unusually rapid and occur as a result of P/E compression, resulting from policy risks not weak GDP. By definition, that comes as a surprise and necessitates advance positioning in 20 defensive S&P industries.

If you are asking why Stifel feels now is a good time to move to more defensive areas, a lot of it rests with the policy that could be forthcoming from the Federal Reserve, as opposed to gross domestic product growth, or lack thereof. While there was initial relief on Wednesday when it became clear that the Fed only plans three rate hikes this year, the Stifel view is that the Fed’s 2019 and 2020 view is considerably more hawkish.

The strength in the stock market since 2009 has been on the lowest interest rates in generations, which were for years parked at zero or just above. This made fixed income, especially investment grade, a lousy investment choice. So despite the wretched bear market of 2008 to 2009, investors piled back into stocks, which in 2009 and 2010 were incredibly cheap. Therefore, the Fed put was reborn, and it has been in full effect for years.

Derived from the concept of a put option, the Fed put term refers to central bank policies that effectively set a floor for equity valuations. For instance, Alan Greenspan was known for lowering the federal funds rate whenever the stock market dropped below a certain value, which resulted in a negative yield. Stifel feels that Fed Chair Powell wants to fade the Fed put, which in turn could cause a 16% price-to-earnings drop.

The Stifel team also points out that investors have become increasingly numb to risk, something that is just the opposite of risk reaction after an economic catastrophe, and they feel that investors need a little more, in their terms, acrophobia, which is an extreme or irrational fear of heights, specifically market heights.

While many of the uber-bulls on Wall Street would challenge the Stifel thesis, citing growing earnings, the potential for more and steeper stock buybacks as the result of repatriation of funds from overseas and a host of other reasons, the bottom line is that on a price-to-earnings metric the market is, on a historical basis, fully valued. So anything that could upset the current financial apple cart could have a big effect.

The Stifel report cites the possibility it could be early in its warning. However, the firm doubts that it is. Stifel moves from having favored a reflation trade through this year to now favoring a deflation trade for 2018. And next year it sees the potential for a bear market and, after that, what it terms a “lost decade” for stocks.

As with all opinions, the firm could indeed be wrong, but what if it is right? What should investors do? Review your holdings, take profits on winners, especially those in which you have long-term capital gains. Move to more defensive areas of the market, which could include utilities, consumer household products, pharmaceuticals and real estate investment trusts (REITs).

Plain and simple, we most likely are due for bear market, and while they are never the end of the world as we know it, they can be painful to the point that you don’t even want to look at your brokerage statement. Now’s the time to get out of the way of the tsunami of a bear market, because when it does come, it could be fast and furious.

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