Via JPM:
Our price target for S&P 500 at the end of 2018 is 3,000 and our earnings forecast (including tax reform) is $153. Half of the earnings upside (~$10) is due to tax reform, and the other half due to top line growth (~$7), margin expansion (~$1.50) and buybacks (~$2.50). To reach the price target, bond yields should not rise too much as that would destabilize the equity multiple. Yesterday’s Fed announcement did not indicate an increased pace of tightening. Opinions differ on the number of hikes in 2018, level of long term rates and impact of G4 central bank normalization. We think that risks for equities will start rising significantly mid-next year as the monetary accommodation is reduced and the level of interest rates increases. This will also be the main driver of an uptick in market volatility in our view.
The upcoming reduction of US corporate tax rates may be one of the biggest positive catalysts for US equities this cycle. It will likely result in a rotation from bonds to equities, from international to US equities, and from Growth to Value stocks. We have extensively analyzed the impact of this reform, and the degree to which its impact is reflected in prices. We think that little is priced into the market and hence there is potential for market upside and significant style and sector rotation to be realized. Discussions with most of our clients support this thesis – clients are not repositioning portfolios until they see the reform passed. Sell-side analysts are also not revising earnings estimates until there is certainty on all of its details. As the reform passes, we expect hedge funds will reposition first, then real money fundamental investors, and finally quant models that will pick up revised earnings estimates, quality metrics or change in price momentum over several subsequent months. We are very early in this rotation.
