What’s traditionally the most important driver of the stock market will retake its place in the new year, according to Jeffrey Saut, the chief investment strategist at Raymond James.
Corporate earnings growth in the US has slowed for months, while the bull market continued and stocks rose to all-time highs with a few pauses here and there.
The whole time, it was an interest rate-driven bull market, Saut said in a note to clients on Monday. Low interest rates reduced debt expenses, making it easier for companies and consumers alike to access leverage.
However, profits are set to become the primary focus of markets again in 2017: interest rates have bottomed, Saut said, and tax cuts under the new administration could bring substantive earnings growth.
Saut wrote (emphasis added):
“To be sure, yearend letters are always hard to write because there is a tendency to discuss the year gone by, or worse to predict what is in store for the new year. Quite frankly, how many pundits predicted Brexit, or a Donald Trump victory? Certainly it wasn’t Andrew Adams or I. Yet, we think by far the biggest message as we prepare to enter 2017 is that the equity markets are transitioning from an interest rate driven bull market to an earnings driven bull market.“
The S&P 500 recorded 3.1% earnings growth in the third quarter according to FactSet, ending a five-quarter streak of declines. Earnings are estimated to grow by 3.2% in the fourth quarter and could mark the first back-to-back period of gains in two years.
None of that would reflect the impact of tax cuts; a 1% drop in the corporate tax rate theoretically adds $1.31 to S&P 500 earnings, according to Reuters.
Saut reckons that getting the corporate tax rate to 15% “could prove to be difficult.” “Still, a 25% tax rate would produce an earnings estimate for 2017 of ~$144,” he wrote.
“Again holding the price/earnings ratio constant at 17x gives us a price target for the S&P 500 of roughly 2450 in the new year [$144 x 17 = 2448]. In either event, we believe stocks are going to trade substantially higher over the next few years. Will there be pullbacks? You bet there will, but in our view pullbacks are for buying.”