Nervous about U.S. stocks? Some strategists believe pessimism is good news

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Global economic activity is slumping, corporate profits are declining and weaker commodity prices are signalling tepid demand – but some strategists are growing more optimistic about U.S. stocks.

Lori Calvasina, head of U.S. equity strategy for RBC Dominion Securities, now expects that the S&P 500 Index will finish this year at 4,250.

That marks a 3.6 per cent increase from her previous target of 4,100 for the U.S. blue chip index and implies a gain of 1 per cent from its level on Tuesday.

That’s not a particularly bullish scenario, but it means she expects that the S&P 500 will finish 2023 with a gain of more than 10 per cent.

More importantly, the expected gain over the next seven months suggests that the clouds hanging over the stock market right now and weighing on broader investor sentiment are not particularly worrisome to some observers.

“Overall, the backdrop for U.S. equities is filled with conflicting crosscurrents, far more than we can remember in our 23 years working in equity strategy,” Ms. Calvasina said in a note.

She added: “While our new target still reflects a fairly neutral view on the direction of stocks through year end, when asked we do acknowledge more upside risks than downside risks.”

Last week, Savita Subramanian, equity and quant strategist at Bank of America, raised her year-end estimate for the S&P 500 to 4,300, marking a 7.5 per cent increase from her previous target of 4,000.

That, too, implies tepid gains from the index’s current level – but also suggests that some strategists are beginning to push back against what they see as overly pessimistic sentiment, which can serve as a contrarian signal to buy stocks.

Sentiment surveys from the American Association of Individual Investors – which have tended to serve contrarians well in the past – have shown that small investors have little appetite for stocks right now.

Throughout May, about 40 per cent of respondents to the weekly surveys said they felt bearish about the stock market over the next six months. That is well above the historical average of 31 per cent of respondents who felt bearish, even though the S&P 500 has rebounded by about 20 per cent since mid-October.

Ms. Subramanian said that the average stock allocation recommended by Wall Street strategists has plummeted to its lowest level, relative to bonds, since 2009, amid widespread concerns today about geopolitics, the U.S. debt ceiling, the regional banking crisis and an oncoming recession.

“For the bear case, talk to the person next to you,” she said in her note.

Ms. Subramanian’s enthusiastic case for stocks rests not only on sentiment, though. She also bats down concerns about high equity valuations that point to the S&P 500 trading at 21 times estimated earnings for 2023.

While that reading is elevated, she argued that it reflects so-called trough earnings – or corporate profits that are at their lowest point in a business cycle, creating a distorted snapshot. Normalized earnings for 2024, point to a more reasonable – though hardly cheap – valuation of 19 times earnings.

Ms. Calvasina said that the stock prices tend to discount earnings trends well in advance. That may be why the S&P 500 touched a low point back in October, as stocks reflected an earnings downturn this year. The index, now higher, is pricing in an earnings recovery in 2024.

“Historically, the S&P 500 bottoms three to six months before the downward revisions cycle is done. The market bottom missed that window this time around, but only by a month,” Ms. Calvasina said.

She raised her 2023 profit estimate for companies within the S&P 500 to US$213 per share, up from US$200 previously, after companies reported better-than-expected profit margins in the first quarter. For 2024, she expects profits will rise to US$223 per share, underpinning a potential shift in investor sentiment.

Neither strategist is expecting big gains for the S&P 500 for the rest of this year. But their improving outlook stands as a challenge to investors expecting the worst.