Wells Fargo's Equity Strategy Outlook: Prepare For Continued Economic Slowdown

Wells Fargo’s analysts reduced the 12-month forward S&P 500 fair value estimate from 2,245 to 2,100. The downward revision is a result of a change in the EPS estimate and PE model.

The S&P 500 EPS, PE and fair value estimates have been impacted by a lackluster end to the year, another reset in oil prices, tighter credit conditions and a flatter yield curve, the analysts said. The estimate for EPS growth in 2016 has been reduced from 8 percent to 4 percent. EPS growth is expected to accelerate modestly to 5 percent over the 12 months ending in 1Q17.

“Reductions to the usual commodity-sensitive suspects - energy, materials, industrials, staples - and financials drive the bulk of the estimate change,” the analysts wrote.

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“Meanwhile, our risk-adjusted PE model suggests the index is fairly valued at 17X EPS if inflation stays moderate, the Fed edges policy rates higher and corporate credit spreads tighten modestly from current levels,” the analysts added.

Wells Fargo continued to recommend investors to prepare for continued slow growth in the broader economy, and maintained an Overweight stance on the technology and discretionary sectors.

Consumer discretionary sector is likely to record 15 percent EPS growth in 2016, ahead of the consensus expectation of 12 percent, since wages continue to rise, confidence remains reasonably strong, and consumer services maintain pricing power.

The analysts expect stocks to head north over the next 12 months, albeit not as strongly as was earlier expected. They mentioned, “We suggest the strongest earnings growth in the index is likely still concentrated in consumer sensitive services segments, particularly those in the technology and discretionary sectors, and suggest investors position with this earnings strength.”