What It Will Take for Stocks to Keep Climbing

What It Will Take for Stocks to Keep Climbing

OPEC has finally reached a real deal to cap production levels — something that has been teased since February.

But the market’s initial move higher in response to the news faded, a sign Wall Street pros are growing nervous about the epic November rally that has, for one notable example, taken the Russell 2000 up 14 percent from its pre-election low.

The chatter from trading floors, according to Briefing.com updates, is growing concern over market valuations.

This is pushing back against what is actually a fairly solid result from OPEC, despite lingering concerns about non-OPEC participation and overall enforcement.

Related: Oil Prices Jump as OPEC Proves It Still Packs a Punch

The cartel will cap output at 32.5 million barrels per day (a 1.2 million-barrel cut) in a six-month agreement that starts in January and could be extended another six months in May. They are also seeking a cut of 600,000 barrels per day from non-OPEC producers, of which about half would come from Russia.

Iranian production will rise by 90,000 barrels from October levels to 3.797 million barrels per day, a decrease from the 3.9 million the Iranians had wanted. Saudi production will be cut by nearly 500,000 barrels, the bulk of the cuts. Iraqi production will be cut by 210,000 barrels. And Indonesia is "suspending" its membership in OPEC, ostensibly because it didn't agree to the cuts and any decision by OPEC needs to be unanimous. OPEC officials claim the cap at 32.5 million barrels includes Indonesia's output, however.

Related: Why This Will Be a December to Remember for Stocks

Relief that OPEC was able to come to a decision should help lift energy stocks over the next couple of weeks. Exxon Mobil (XOM) looks like the best way to play this as shares emerge from a multi-month consolidation range, a position I have recommended to clients.

XOM Chart

XOM data by YCharts

Broadly speaking, the energy sector has been comatose since the summer as optimism over OPEC's hints of a production freeze gave way to a long and tortuous negotiation process. But the rally has been enough to push the Energy Sector Select SPDR (XLE) above its 200-week moving average for the first time since June 2015, ending a two-year bout of weakness.

Is all this too much too fast?

According to FactSet, the S&P 500 is trading at approximately 16.8 times forward 12-month earnings. That's a 17 percent premium to the 10-year average.

Related: Trump's Twitter Rants Create a New Risk for Stocks

If stocks are going to continue their upward trajectory, these valuation measures will need to be deflated by earnings growth. There's room for optimism, as S&P 500 companies managed to end their two-year-long earnings recession in the third quarter thanks to a stabilization in the dollar and energy prices. Moreover, the 2.7 percent year-over-year growth in revenues was the first top-line expansion since the end of 2014. An impressive feat.

Optimism is high that the growth will continue into the current quarter, with earnings growth of 3.3 percent and revenue growth of 5 percent expected. Yet the risk remains that investors cool their heels and await confirmation that the OPEC deal will stick, oil will continue its climb and corporate earnings growth will continue its recent recovery.