There’s juice in the equity rally yet.
A second-quarter earnings season that’s set to beat the consensus and reinvigorated faith in the Trump Administration’s policy objectives will spur the S&P 500 Index about 10 percent higher to a record 2,700 by the end of the year, according to Morgan Stanley Chief Equity Strategist Michael Wilson.
"The U.S. equity market can continue to grind higher on the back of improving earnings as it has done for the past several months," Wilson wrote in a note Monday. He reiterated his April call for the U.S. benchmark.
Key to his bullish outlook: The S&P’s 12-month blended forward price-to-earnings ratio should move higher after softening since March as market confidence in the President Donald Trump’s ability to implement pro-growth measures dwindled.
A signal that health-care and tax reform is on the horizon should trigger capital spending and merger and acquisition activity that will buoy 2018 earnings and higher equity valuations, the bank argues.
"Very little to no tax benefit has been baked into 2017 and maybe even 2018 consensus earnings-per-share numbers," Morgan Stanley strategists wrote. "We think the catalyst on P/E expansion will be more policy ‘certainty’ rather than the outcome itself."
A solid earnings beat for the second quarter amid low expectations, continued monetary stimulus, and an improvement in the equity risk premium -- the excess return the stock market is projected to deliver over a risk-free rate -- will rally the market over the next two quarters, according to the U.S. bank. On this basis, it projects the forward earnings ratio should approach 19 times over the next two quarters, from around 17.5 currently. Morgan Stanley’s end-year S&P target is the most bullish among 20 strategists surveyed by Bloomberg News last month.
Wilson and team are pushing back against equity bears, who argue that earnings estimates are priced for perfection given the weak U.S. expansion and price growth in the real economy, while corporate leverage is at record levels.
"No matter what gets passed in the next few months, we think just movingforward with a decision on the Affordable Care Act and taxes will provide thecertainty necessary for companies and individuals to ‘act’ on their higherconfidence readings which have remained elevated," the strategists conclude.
This article was provided by Bloomberg News.