Investment strategists considering what’s next for the nearly seven-year-old bull market tend to agree with the late baseball legend Yogi Berra: It ain’t over ’til it’s over. 

No one is predicting any home runs, but they think the bull market for U.S. equities can persist through 2016—and maybe beyond. As strategists see it, the U.S. economy is still growing, the Federal Reserve is likely to raise rates extremely slowly, the global central banks remain very accommodative, and the stock market tends to rally after presidential elections.

Of course, all bets are off if inflation heats up or if China sinks into a recession, but strategists don’t expect either one of those things. They’re also creating similar playbooks with a big emphasis on the technology, financial and consumer discretionary sectors. 

Economist Ed Yardeni, president of Yardeni Research, thinks the U.S. equity market will be mostly driven this year by earnings, though he adds, “It’s hard to get wildly optimistic about earnings because profit margins are already at a record high and the outlook for revenues is not exciting.” That’s because global economic growth, largely dampened by a slowdown in China, will likely remain subpar, he says. 

The good news is he doesn’t see China or the U.S. pulling into a recession this year. “It’s usually recessions that trip up bull markets and lead to bear markets,” he says.

Yardeni expects earnings to rise at best by 5% to 7% in 2016, right in line with the gains he anticipates for the stock market. That’s assuming there isn’t much upside in price-earnings multiples, which are also at record highs, he says. 

The Federal Reserve has no intention of causing a recession, he says, given the fragile state of the U.S. and global economies and very low inflation. So he’d be surprised to see it hike the federal funds rate more than twice by the end of 2016, or by more than 25 basis points either time. (He thought the first hike might come at the Fed’s mid-December meeting, to be held just after this issue went to press.) 

Yardeni sees continued challenges for sectors exposed to the global economy and to commodities. He thinks the consumer sector will remain strong, but notes that wage pressures are starting to cut into margins and could result in some disappointments for retailers. Meanwhile, strong regulations have muted financial companies’ ability to surprise to the upside, he says. 

“I think if we’re looking for upside surprises next year, it’ll probably be in information technology,” he says. “I think it’s just a continuation of what we’ve seen—large-cap IT stocks that are very much exposed to the Internet in general and to the cloud in particular.”

More To Go

Technology also remains a top sector for Charles Schwab & Co, says Brad Sorensen, the head of market and sector analysis for the Schwab Center for Financial Research and a member of Schwab’s Investment Strategy Council. Technology has been an outperformer, he says, and the firm thinks that can continue.

Innovation is plentiful, consumer spending continues to be very directed at technology, and several surveys suggest that companies may finally be willing to boost their capital expenditures—especially on technology, in order to enhance their efficiency and productivity, Sorensen says. The current rate of capital investment continues to lag historical averages, he notes.

The one area of technology he cautions about is hot: social networking. “We do think there’ll be some winners in there, but not all of them can be winners because they’re all chasing the same ad dollars,” says Sorensen, “and at this point there isn’t a sustainable revenue model for charging actual users of those services.”

His team expects the financial sector to outperform this year. Its valuations look relatively attractive next to other sectors and next to much of the market, which the team thinks is slightly overvalued. “A lot of the bad news has already been priced into those stocks,” says Sorensen. “We’re seeing some of the fundamentals improve, and they should get a tailwind from the Fed coming off its zero interest rate policy.” Improving fundamentals in the financial sector include an increase in total loan growth, a continued drop in nonperforming loans, a decline in foreclosures and financial companies’ better expense management.

As for the entire stock market, “we think stocks will continue to move higher, but it’ll be much more of a grinding higher than what we’ve seen over the past few years,” he says. Modest gains will likely be accompanied by additional volatility spurred by uncertainty about the Fed’s activity and the election, he says. “Biotech, for example, took a pretty big hit from some campaign rhetoric,” he says. “But traditionally the presidential election year is a decent year for the stock market.”

 

Omar Aguilar, the chief investment officer of equities at Charles Schwab Investment Management, the asset management arm of Charles Schwab Corp., says the stock market has historically rallied after presidential elections, regardless of the winning party. Overall, though, “We’re not going to have a big gangbuster year,” he says. He expects single-digit returns for the S&P 500, assuming there will be a fairly stable U.S. economy and a low probability of inflation. 

“I think what worries me the most is the emerging markets recovery,” Aguilar says. China will do what it takes to stabilize its economy and markets, he says, “and that obviously will create some headwinds for the rest of the world.” 

Aguilar expects financial companies to benefit from a slight increase in the federal funds rate. He expects the technology and consumer discretionary sectors, particularly automakers, to fare well this year given the continued economic recovery coupled with rising consumer confidence and full employment. Although he anticipates more election-driven volatility for health-care stocks, his long-term outlook for the sector is strong because the global population is growing and people in developed economies are living longer. 

Rob Sharps, a portfolio manager for the T. Rowe Price U.S. Large-Cap Growth Equity Strategy, which has $36 billion in assets under management, thinks we can still have another few years of this bull market following its recent mid-cycle pause. “We had to absorb that energy-patch weakness that also bled into other industrial areas of the economy,” he says, “and we had to absorb that dollar strength.” 

His outlook for 2016 includes GDP growth of 2.5% to 3.5%, a resumption of profit growth in the mid- to upper-single digits, a modest multiple expansion as people gain confidence, and a return of approximately 10% by the S&P 500—plus a little bit of dividend return. It will be difficult for energy or other commodity-oriented sectors to contribute, Sharps says, “absent that sort of coordinated, global, booming economic growth.” Instead, he favors the financial, health-care, technology and consumer discretionary sectors.

Sharps thinks returns will be driven by continued merger and acquisition activity, as well as by innovation. Moreover, “You have this really strange
dynamic right now where the lack of global growth and the lack of profit growth has accelerated the ability of disruptive business models—companies like Amazon and Netflix—to go after more traditional business models,” he says. 

His largest position is Amazon, which he’s held in the portfolio for 10 years. “I like the fact that they’re dominant in e-commerce, where I think they continue to have a long runway,” he says. He also likes Amazon’s fast-growing cloud computing business. In health-care, Sharps sees opportunities in biotechnology and HMO companies. 

Stronger Doubts

Longtime bull Jim Paulsen, chief investment strategist at Wells Capital Management, predicts a “flattish” year for the U.S. equity market. “It can’t keep going up the way it’s been going up,” he says, citing relatively high valuations, a likely rise in interest rates and an aging earnings cycle. 

He’s also concerned by “a shift in market mathematics,” he says, as the U.S. approaches full employment—an unemployment rate of 5% or less. Since 1948, annualized stock returns have been nearly twice as strong when unemployment exceeded 5% than when it was 5% or below, Paulsen says, while long-term government bond returns were almost four times greater. Additionally, stocks and bonds have tended to suffer more frequent monthly declines in fully employed economies, he says.

But the negative effects of full employment on the financial markets could be dampened by accelerating productivity. “I don’t know if it’s super likely, but I think we’re going to get some pickup,” says Paulsen. He notes that this has been the worst productivity of any postwar recovery. Rising productivity would stave off price increases and inflation, and could be, as in the 1990s, “a key to the bull market kingdom,” he says. 

He says he’d still be overweight in stocks, given the current risks associated with bonds and the nonexistent returns on cash. But he’d have minimal exposure to U.S. stocks and favor different developed and emerging markets. Other countries are still doing quantitative easing, they aren’t at full employment or as far along in their economic recoveries, and they also have more room for earnings growth because their profit margins aren’t as high, he says.

He’d move toward the producer and capital goods sectors—materials, energy, industrials and technology—because he expects producer prices to rise faster than consumer prices. He also likes commodities. “I think commodities are going to bounce a little over the next year,” he says.

Given his outlook for a small pickup in inflation, Paulsen would be overweight in mid- and small-cap companies rather than large caps because, he says, “They run with leaner, meaner margins.” He also notes that the Russell 2000, unlike the S&P 500, is quite a way from its record highs.

So there you have it. Although there are no crystal balls for the New Year, at least no one expects a wrecking ball to smash stock prices.