7/22/15

With the overhang of Greece finally lifting, there are several reasons to be optimistic about the potential for a nice run in stocks through the second half.

For the quarter ending in June, the S&P 500 posted its worst quarter since 2010. It just so happens that the pressure on stocks back in the first half of that year, like this year, was due to the potential default of Greece. As we know, Greece was bailed out by the IMF, ECB and Euro partners in 2010. And in the second half of that year, the S&P 500 rallied from down 7% to up 15% by year end.

The Russell 2000 was down 6% for the year through July of 2010. Over the next five months it rallied 34 percentage points to finish UP 27% on the year.

What about energy? Another drag on sentiment in 2010 was the Gulf Oil Spill. Energy stocks were smashed. After being down 12% in the first half of 2010, the
XLE (the energy ETF tied to a basket of energy stocks) returned 34% off the bottom and 22% for the year.

Also consider this: According to research done by Guggenheim Partners, in the five months leading up to a Fed tightening cycle, stocks have historically rallied 9%. We’re well behind on that timeline at this point. That creates a scenario where we could see a very sharp rally to catch up.

What about valuations?

The consensus earnings forecast for the S&P 500 for 2016 is $126. At the current P/E multiple for stocks, it projects a move to 2,709 in the S&P by next year (P/E of 21 x earnings of $126 = 2,646). That’s 26% higher than current levels.

What if the economy sours?

The best predictor of recessions historically has been the spread (the difference) between the 10-year Treasury bond rate and the 3-month T-bill rate. That measure is showing the probability of a recession next year at around three percent — virtually nil.

So we have some very compelling reasons to be excited about the backdrop for stocks into the second half of the year, especially when we consider that central banks need stocks to continue higher. With that said, the Fed remains extremely accommodative, even if they do make their first rate hike in nine years in the coming months. The ECB and BOJ continue to provide fuel for global stocks through their massive QE programs.