(Bloomberg) -- Investors banking on the “Fed Put” keeping the equity rally going should be getting worried about the direction of earnings growth, according to UBS Group AG.
A decline in forward earnings growth for S&P 500 Index members below 0% would likely bring an end to the “bad news is good news” dynamic that’s helped propel the year’s stock rally, strategist Francois Trahan wrote in a note Tuesday. History shows the bullish effect from expectations of Federal Reserve stimulus ended after growth turned negative, he said.
Twelve-month estimated earnings growth for the S&P 500 Index has slumped from over 20% late last year to just 3% currently, according to data compiled by Bloomberg.
“In the last 20 years, ‘rate-cut rallies’ have proven to be short-lived as market multiples expanded temporarily but eventually started to compress again in the face of weaker leading indicators,” Trahan wrote. “In 2001 and 2007 the ‘Fed Put’ ended when S&P 500 earnings growth fell to 0%.”
U.S. stocks have surged to record highs this year despite concerns over slowing global growth and the impact of U.S.-China trade tensions. Investors are betting Fed stimulus can avert a U.S. downturn, and traders have priced in more than two quarter-point rate cuts by the end of the year.
Trahan sees similarities between markets now and those of 2001 and 2007, when investor sentiment also saw revivals thanks to Fed easing.
“Then, as now, the equity market ignored negative economic developments for a time as investors hoped that bad data would entice the Fed to add more stimulus,” he said. “Eventually, however, the equity market returned to ‘normal’ and began to respond negatively once again to disappointing economic news.”