What to Watch in Stocks After the Lever Drops

Earnings, the economy and valuations await Wednesday's opening bell.

The financial markets, much like the rest of America, have become fixated on the outcome of the presidential election. 

That's understandable, given that markets -- which famously hate uncertainty -- were forced to contend with the late momentum of a candidate who is the personification of uncertainty.

However, let's assume for the time being that the election plays out according to the polls and that the opening bell is rung on Wednesday after an irrefutable victory by Hillary Clinton.

What on Earth will they have to worry about then? Fear not, there's always something to worry about. And in this case, the worries should be all too familiar. 

Earnings, for one thing. Though if you're in the market for reasons to worry, there's not as much to work with here as there once was. With more than 85 percent of third-quarter reports in the book, it appears as though the so-called earnings recession has ended. The companies in the S&P 500 that reported so far showed adjusted profit growth for the index of 3.2 percent and sales growth of 2.2 percent.

The outlook for coming quarters is even better:

Rosy Outlook

Earnings growth for S&P 500 companies is expected to rebound to double-digit percentages next year

Source: Bloomberg

Note: Year-over-year share-weighted earnings growth based on Bloomberg earnings estimates for individual companies

However, these estimates should be taken with more grains of salt than the Democrats will put on the rims of their celebratory post-election margaritas for a few reasons. For, one, consider how earnings growth was expected to be strong in 2016 but is now forecast to be flat:

Better Luck Next Year

Double-digit percentage earnings growth for S&P 500 companies was once forecast for 2016

Source: Bloomberg

Also, the forecasts for growth in U.S. gross domestic product in 2017 have come down considerably and even imply a small (but not quite negligible) 20 percent chance of recession:

Tempered Outlook

Economists surveyed by Bloomberg currently forecast 2.1 percent growth in the U.S. economy in 2017

Source: Bloomberg

And it's important to point out that energy companies are far and away expected to post the best earnings growth: a whopping 337 percent in 2017 and 45 percent in 2018.

Yet that will take cooperation in the price of oil, which has come under pressure lately. That weakness may have only a little to do with the risk-off appetites in markets in the two weeks before Monday and more to do with concern that OPEC will struggle to make good on plans to cut production. Oil stabilized and recovered a bit on Monday but not at the breakneck pace seen in prices for other risky assets:

Slippery Slope

Oil has struggled to stay above $50 a barrel this year, suggesting a recovery in prices may be stalling

Source: Bloomberg

Then there's our old friend the Federal Reserve.

The recent risk-off tone in markets seems to have done nothing to stop a December interest-rate increase from looking more and more likely.

A Sure Thing?

Fed funds futures trading has pointed to a steady increase in probability of a December hike

Source: Bloomberg

And finally there are valuations, which remain near the higher end of the spectrum regardless of what flavor of ratio you prefer:

Still Pricey

S&P 500 valuations have remained elevated despite the recent pre-election risk aversion

Source: Bloomberg data

Note: Forward P/E is based on earnings estimates for teh next 12 months

None of this should preclude a relief rally in stocks from continuing if Clinton is elected, especially if it's on the market's preferred terms that include Republicans controlling Congress and tempering her ability to reshape regulations too broadly. And who knows, maybe the relief rally will flow right into a Santa Claus rally that will send benchmark indexes knocking on the door of new highs by the end of the year.

Still, while the chances of Democrats winning a third consecutive term in the White House are looking cautiously optimistic, a lot will need to go right for the bull market to storm into the first year of that term with the same sort of strength it showed off in the Obama years.  

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Michael P. Regan in New York at mregan12@bloomberg.net

    To contact the editor responsible for this story:
    Daniel Niemi at dniemi1@bloomberg.net

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