A Citi stock model with a good track record forecasts a 90% chance of gains in next 12 months

Finance

Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., January 10, 2020.

Brendan McDermid | Reuters

With the S&P 500‘s valuation approaching its peak in a record-long bull run, investors worry the market is likely to go nowhere in 2020 following a historic year. But by Citi’s measure, there’s a good chance investors would enjoy another up year.

Citi’s “normalized earnings yield gap analysis” showed a near 90% chance of market gains in the next 12 months, according to the bank’s chief U.S. equity strategist Tobias Levkovich. He argued the widely-watched S&P 500 price-to-forward-earnings ratio could be skewed by low rates due to global central banks’ quantitative easing measures.

“We do not see the makings of a bear market based on our indicators,” Levkovich said in a note Wednesday. “We do not see the pent-up demand that would generate a new S&P 500 or Nasdaq bubble either.”

Citi used cyclically adjusted the price-to-earnings ratio and the five-year forward swap contract level for 10-year Treasury yields to determine valuation. The analysis showed current market valuation is  between one and two standard deviations below average going back to 1971.

“Given global QE, there is a legitimate argument to be made that a distortion in yields may be sending the wrong signal for valuing stocks,” Levkovich said.

The S&P 500’s price-to-earnings multiple is nearing the highs reached in early 2018, which preceded a market correction in just a few weeks. But this time could be different as the Federal Reserve reversed course last year by cutting interest rates three times, the strategist said.

“Low bond yields are cited as providing a reduced discount rate such that much higher multiples can be appropriate,” Levkovich said.

The S&P 500 scored its best year in six last year, rallying almost 29%. The benchmark has risen 2.5% in 2020.

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