December 18, 2016 / 6:04 PM / 8 months ago

Wall St Week Ahead-Hurdles emerge for stocks after rally

(Repeats story first published on Friday with no changes to
text)
    By Chuck Mikolajczak
    NEW YORK, Dec 16 (Reuters) - Benchmark U.S. stock index
rallies, in anticipation of fiscal stimulus measures by the
incoming administration of President-elect Donald Trump, could
also be laying the seeds for equity market troubles from a
stronger dollar and rising bond yields.
    The S&P 500 stock index has surged over 8 percent
since the Nov. 8 election, due in large part to sectors that are
expected to benefit from an inflationary policy. The S&P
financial sector has led the charge, with a gain of more
than 17 percent. 
    "We are putting fuel on the fire here potentially, because
nothing has actually happened, everybody is acting like it is
already happening," said Richard Bernstein, chief executive
officer of Richard Bernstein Advisors in New York. 
    Those expectations, along with improving economic data and
the U.S. Federal Reserve's recent decision to raise interest
rates while signaling a quicker pace of hikes next year, have
also served to strengthen the dollar and push bond yields
higher. 
    It is the rising dollar that risks undercutting the earnings
of large multinational firms, just when the overall earnings
from S&P 500 companies were ending an earnings recession in the
latest quarter.
    And while rising bond yields may be beneficial to banks,
they lift the overall cost of capital for companies and shrink
the relative valuation advantage stocks have had over fixed
income investments since the financial crisis. 
    "The thought is that earnings will be better and the economy
is strong enough to be able to withstand higher interest rates,
and that is why we're not seeing a decline in stocks," said Paul
Nolte, portfolio manager at Kingsview Asset Management in
Chicago. 
    "That being said, the stronger dollar and higher interest
rates will at some point filter through to earnings. It's just a
matter of when and how." 
    The dollar hit a 14-year high of 103.56 against a
basket of major currencies following the Fed's announcement on
Wednesday. Stocks also appear to be getting pricey, with the
current price-to-earnings ratio for the S&P 500 at 20.8, well
above its long-term average of 16.6, according to Thomson
Reuters data. 
    Higher bond yields is also increasing bonds' attractiveness
over equities. The S&P 500 dividend yield is 2.07 percent versus
a yield of almost 2.6 percent for the benchmark 10-year U.S.
Treasury after its sixth straight week of gains.
 
    "That is a big valuation disconnect, that will continue to
keep people invested in bonds," said Greg Peters, Senior
Investment Officer at PGIM Fixed Income in Newark, New Jersey. 
    These twin challenges for equities could be mitigated,
however, should the economy continue to improve. A climb in
rates and the dollar are hallmarks of economic growth, provided
the increases happen at a steady pace.
    "This economy is in good shape in our view," said Ryan
Detrick, senior market strategist at LPL Financial in Charlotte,
North Carolina. 
    "So, rates are rising for the right reasons and the economy
is proving that, and that should be a potential positive for
equities." 

 (Additional reporting by Caroline Valtekevitch and Trevor
Hunnicutt; editing by Daniel Bases and Nick Zieminski)

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