The VIX (volatility index) should be at 20 and the S&P 500 index should be at 1,970 said Julian Emanuel, US equity and derivatives executive director at UBS. Investors need to remind themselves that the current environment is different from the past 3 ½ years; it’s a high-volatility environment.
The rubber band was stretched to the downside in February and a massive capitulation was witnessed. UBS thinks markets will end up higher toward the end of the year; but when the VIX trades back down to 14, the market has essentially gone up in a straight line at the same time expectations for the economy in the first quarter from 2 percent growth to the Atlanta Fed’s GDP growth forecast now at 0.4 percent indicating there’s a disconnect there, he noted.
Asked how markets can end higher for the year if the S&P 500 drops to 1,970, Julian said the current narrative is one of those stories where the investors are finding their footing, the economy is finding its footing and its very clear the Fed is going to err on the side of dovishness, which means market participants need not worry about rates running away.
At the end of the day when stocks are trading in the neighborhood of 16-17 times (PE multiple), and when there’s earnings-growth potential for 2017, UBS thinks that’s a good multiple, he explained.
While 30 percent global bonds are at negative rate, the US rates are not expected to rise any time soon. Asked if that’s equally bad for the economy, Julian said that’s definitely an issue and that explains why investors are so perturbed by what happened to the yen.
Negative interest rates were supposed to weaken the yen. But whether its cash under the mattresses or other reasons, it strengthens the currency and that’s been the reaction that’s happened in Japan over the course of the year and the outcome is definitely in question, he observed.
Negative interest rates may never work for Japan the way it works for other economies since it’s a savings economy. However, if rates are negative, they are supposed to put an upward bias on equities that are delivering yields that’s significantly better on a relative basis even in a poor earnings environment.
Asked to explain, Julian said negative interest rates should boost equities, but investors need to see the first part of the equation, which is stoking of inflation. Gold prices are indicating inflation is starting to be an issue. In the current environment that’s a positive – only if that resumes economic growth.
In the current wait-and-see attitude, UBS likes healthcare on the pullback. That’s a sector that’s going to grow earnings in the first quarter, which is a very dicey quarter coming up in the next week, but also throughout the year. The sector has been left for dead – given politics, given the volatility in Pharma, given the fact the markets witnessed a major merger break, UBS thinks healthcare is going to work now, he noted.
Asked which among the 10 major sectors of S&P 500 face the most downside risk, Julian said though it may look counter-intuitive, both cyclical and defensive stocks got bid-up in the past three months, which doesn’t really make sense. Consumer staples are trading at their highest multiples of all time, which is almost a defensiveness bubble. So if economic news turn around and gets better over the next several weeks, and if news from Japan improves and 10-yields start to move up, the consumer staples sector would get very vulnerable in UBS’ view, he concluded.
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