Markets got a reprieve from the Fed as it slowed the pace of QT while leaving two cuts on the table. Powell's comments also signaled willingness to look through tariff price level impacts as transitory inflation.
This was significant as it reduces the probability of a left tail scenario for equities where tariffs weigh on earnings alongside Fed tightening hurts multiples. Additionally, normalizing sentiment is another encouraging development. The Levkovich Index retreated from euphoria to neutral.
Furthermore, trailing multiples have compressed down inside our fair value range. Together, this signals some froth has been taken out of the market. This is a more balanced starting point for equity markets to manage through evolving first half risks. Recall, we have noted that roughly 5500 on the S&P 500 is a level that better balances risk-reward. This level is the midpoint between our first half bear and base case index price targets.
The ETF industry has thrived post-Financial Crisis with US-listed AUM now topping $10T. Adapting to changing market conditions has been a hallmark of this growth. We see a path to another $10T but with an evolving roadmap. Market share gains from Mutual Funds are a cornerstone, and market appreciation is always a big factor. But an ever-evolving investment paradigm is likely to be critical as well. To be determined is how product evolution faces off with product rationalization.
Following the election and strong macro backdrop, we lowered our cost of equity assumptions to reflect early-cycle levels (~9-10%), but as we take stock now, we feel more comfortable anchoring to ~10.5%, better reflecting through-the-cycle levels. Even with valuation revisions, we see the sector as attractive here, with implied CoE at ~10.7% despite solid underlying fundamentals. While credit risk concerns are tough to disprove, we remain constructive on exposure and reserve levels, which creates good entry point and potential improving loan growth acts as upside call-option.
The return outlook for our names is largely unchanged, but raising our CoE assumptions lowers our price targets ~7% (see Fig 1). We see meaningful upside at top picks ALLY (53%), where we expect improvement in credit trends and are initiating a positive catalyst watch, CFG (26%) with mechanical ramp to better returns, and USB (31%), who we expect to see meaningful NIM expansion.
