In the report, the Deutsche Bank team caution that a near-term 5% to 9% correction could be in the offing, and sector selection could be more important this year than in recent years. They also offered up a list of questions that investors are asking them most frequently.
1) How expensive is the S&P? The current 17.8 trailing and 17.3 forward price-to-earnings (P/E) numbers are rich. In fact they are 10% to 15% above the historical norm. That means two things in essence. Either earnings need to jump or stocks need a sell-off.
2) Is an 18 trailing P/E sustainable, and is there upside? The analysts think yes, if long-term Treasury yields do not go over 3% for the rest of the cycle. With the 30-year bond now at a 2.66% yield, there is not a lot of breathing room.
3) What sectors have the most P/E upside? The Deutsche Bank team like big-cap technology and health care stocks. Many of the firms we cover on Wall Street agree.
4) Which sectors and industries benefit from lower oil prices and which suffer? Usually consumer staples and discretionary, and some transports like the airlines, benefit. Energy, capital goods, metals and mining, chemicals and utilities can suffer.
5) Is the 10% record high S&P net profit margin sustainable? The analysts think yes, but this could be the top. They also see margin pressure in certain sectors, like energy and industrials.
6) Are the S&P payouts sustainable? The analysts think the answer is yes, but also believe that companies may shift from stock buybacks to dividends going forward.
7) Have S&P companies driven earnings-per-share growth with stock buybacks? The analysts point out that only 20% of earnings growth, or 1.6%, is from buybacks since 2012.
8) How will equities and long-term interest rates react to Federal Reserve rate hikes? The Deutsche Bank team thinks that once the Fed does start raising rates, they will continue through next year. They also think rates will not increase past the 2% level (from currently close to 0%), unless labor costs really heat up. They also think this upcoming rate hike cycle will be far different from those in the past, and the key to P/E going forward will again be long-term yields.
9) Should small cap stocks be brought into rate hikes and which ones? Typically small caps outperform in climbing interest rate and stronger dollar scenarios, as many are not big exporters. The analysts feel they could outperform if the S&P avoids a serious slide. They caution that the Russell 2000 premium versus the S&P is still rich.
10) What’s the capital expenditure (capex) outlook? The Deutsche Bank team is expecting 5% capex growth within the overall U.S. gross domestic product (GDP) this year. They see the big drop in capex in the energy sector at least partially offset by better spending in the tech sector.
So reading between the lines is not all that difficult. The Deutsche Bank strategists are cautiously optimistic, but they remain very clear which sectors they feel can offer the best chances for stock investors this year. Plus, again, they are thinking a 5% to 9% correction could be in the cards, and that looks to be a very likely possibility.
Top Gaining Stocks
Top Losing Stocks