Barclays's Five Predictions for U.S. Stocks in 2017
We're officially in the thick of crystal ball-gazing season.
To that end, Barclays Plc Head of U.S. Equity Strategy Jonathan Glionna detailed a list of five predictions for U.S. stocks next year. In a note to clients on Tuesday, the strategist sees rising profits and payouts propelling the S&P 500 Index up by 7 percent in 2017. Here's more:
Adjusted earnings will rise to 'at least' $127 per share
More robust revenue growth will dwarf the downward pressure from wage inflation that's emerged as major threat to corporate America's margins and profitability, as well offset the renewed strength of the U.S. dollar, which reduces the value of profits earned abroad.
A nominal growth rate for the U.S. economy of 4.8 percent in 2017 will be the biggest motor for S&P 500 companies' improved earnings, according to Glionna, who expects them to hit "at least" $127 per share.
"Recall, slow top line growth has been a challenge for more than two years," he writes. "If our model is right, top line growth will reach 3.4 percent in 2017, the best result since 2014."
The "at least" part of Glionna's estimate doesn't take into account the potential for tax reform under Donald Trump's coming administration, which would push his estimate for adjusted EPS up to $133 — the same level that consensus bottom-up forecasts for 2017 are currently sitting at.
Dividends will eclipse $48 per share
Hitting this level would mean payouts-per-share would rise by more than 50 percent over five years.
"To be sure, the pace of dividend growth is decelerating but still ample," the strategist notes, citing an elevated payout ratio. "We believe the strong growth in dividends achieved over the last five years pulled forward some future growth and therefore EPS needs to catch up, meaning an estimate that modestly lags projected EPS growth is appropriate."
Banks will lead the pick-up in dividends per share, he expects, with the real estate sector, as well as autos and components, trimming their aggregate payouts.
Buybacks will stagnate… but at a high level
Glionna expects the roughly $600 billion in share repurchases that S&P 500 firms are on pace to have completed in 2016 will be matched in 2017. However, elevated leverage, higher yields, and the potential that interest deductibility perks may be eliminated under the new administration augur against an increase in buybacks, he says.
"Companies have been paying out more in dividends and buybacks than they can afford based on free cash flow," the strategist writes. "That has led to $1 trillion of additional borrowings since 2013. While the credit markets remain receptive to additional debt issuance we believe companies are beginning to reach credit rating constraints."
On the other hand, Glionna acknowledges that a repatriation tax holiday could potentially spur a buyback bonanza, as strategists at Goldman Sachs Group Inc., among others, have argued.
S&P 500 to 2,400
Glionna's target for the index is tied for the highest number on Wall Street for year-end 2017. You'll notice that his 7 percent advance is equal to his projected rise in adjusted earnings.
This marks the third year that Barclays has not attempted to forecast whether or not valuations (particularly the price-to-earnings ratio) will change, a strategy that has "worked adequately," according to Glionna. He says he finds this tactic especially compelling given where he thinks the U.S. is in the business cycle.
"It is rare for the S&P 500’s price-to-earnings multiple to expand late in a business cycle when earnings are going up," he notes. "Most PE multiple expansion occurs early in a business cycle or late in a business cycle when earnings have begun to decline."
If his upside scenario for earnings growth is realized, the benchmark index could ascend to 2,500 next year. Meanwhile, in a more pessimistic scenario in which rising yields and a strong U.S. dollar kneecap stocks, Glionna sees the S&P 500 falling to 2,000.
Healthcare is the place to be
This sector and its subcategories have been whipsawed by the perceived and professed policy preferences of the president-elect — and that trend has continued after Nov. 8.
"Concerns about drug pricing have been the clear negative catalyst, with President-elect Trump recently assuming the role of the people’s champion against unjustified drug price increases," the strategist writes. "But despite the ongoing political spotlight, which has resulted in biotechnology and pharmaceuticals being the two worst performing industries in 2016, fundamental positives remain." Healthcare has lagged all other S&P 500 sectors this year.
Within the industry, managed care is Glionna's preferred place to be, "followed by distributors, biotechnology, pharmaceuticals, life sciences, and equipment."
The ability to still generate "adequate" price increases and strong cash flow (which points to higher payouts) will buoy these companies in 2017, he says, and their poor performance this year means health care companies can be scooped up at a discount.
"The PE multiple of the sector is now more than one standard deviation below its 10 year average and the lowest of any sector by this measure," concludes the strategist.