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Just before Tuesday's market plunge, two top strategists got more bullish

On Tuesday, stocks had their worst day of the year.

The benchmark S&P 500 broke its 109-day streak of not losing 1% or more in a single session, while bank stocks got absolutely demolished. When all was said and done, the Dow lost 237 points, or 1.1%, the S&P 500 lost 29 points, or 1.2%, and the Nasdaq lost 107 points, or 1.8%. The XLF ETF, which tracks the financial sector, fell 2.9%.

On Wednesday, the major U.S. averages were roughly unchanged, with the Dow slightly lower and the S&P slightly higher.

But Tuesday’s big move lower came after strategists at both Barclays and Credit Suisse this week upgraded their expectations for the S&P.

Barclays Capital traders work on the floor of the New York Stock Exchange. (AP Photo/Henny Ray Abrams)
Barclays Capital traders work on the floor of the New York Stock Exchange. (AP Photo/Henny Ray Abrams)

‘Least expensive major asset class’

In a note published on Monday, strategists at Credit Suisse led by Andrew Garthwaite took their year-end view on the S&P 500 to 2,500 from 2,300.

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“Our clear-cut view is that investors should be overweight equities versus bonds and credit,” Credit Suisse wrote.

The firm said it views the U.S. labor market as still not at full employment — likely keeping the Federal Reserve from raising rates in a manner that would choke off economic activity — while stocks also look more attractive than bonds on a risk-adjusted basis, earnings revisions remain positive, and, in Credit Suisse’s view, stocks remain the “least expensive major asset class.”

Credit Suisse’s chief U.S. equity strategist Lori Calvasina wrote in a separate note, however, that U.S. stock valuations make the market a bit more vulnerable to a near-term decline.

Were the market to trade back to a multiple in-line with its 2015 and 2016 lows, the S&P could fall to 2,100, in Calvasina’s view.

‘Fiscal option’

Meanwhile, equity strategists led by Keith Parker at Barclays, took their year-end S&P target to 2,525, outlining what the firm calls the “fiscal option” that gives markets a potential upside boost this year.

“Our baseline is that a tax plan will be proposed in 2017, but not passed this year,” Barclays writes. “Thus, we expect that the S&P 500 price at the end of 2017 will include an embedded ‘fiscal option.’ Tax reform is a potential late cycle multiplier on both the upside and the downside (i.e. delivering vs. disappointment).”

Source: Barclays
Source: Barclays

The “fiscal option” is basically U.S. lawmakers getting done what they say they want to — tax reform and infrastructure spending. And right now, this hasn’t, in Barclays’ view, been powering markets.

“The S&P 500 was range-bound between late 2014 and mid-2016, and has rallied nearly 15% from those levels,” Barclays writes.

“We prefer to look through the volatility and put the market move over the last 6-12 months into perspective. While it is tempting to say that sentiment and/ or fiscal expectations have driven the equity market higher, a closer look shows that both a recovery in earnings and a re-rating of the multiple have both contributed to the rally.” (Emphasis added.)

All politics?

This view runs somewhat counter both to the prevailing dominant view in markets and that shared by folks like Minneapolis Fed president Neel Kashkari, who said Tuesday that the recent rally in markets, in his view, has been “mostly” about politics.

And while neither the trouble passing healthcare reform nor its potential for imperiling of tax and infrastructure plans were new worries, this was, it seemed, what markers were worried about on Tuesday.

But some strategists, including Marko Kolanovic at JP Morgan, said politics wasn’t the primary trigger for the market’s decline. Kolanovic outlined in a note published Tuesday afternoon that options expiring last week would “lift the lid” from market volatility and likely lead to a decline in stock prices. And so it did.

“We maintain that the market is entering a vulnerable phase, where increased volatility can further contribute to equity outflows,” Kolanovic wrote.

“While we don’t want to minimize the impact of political developments, [Tuesday’s] move was primarily technical and should not be fitted into a political narrative (which in fact was neutral between developments in France and US).”

And Kolanovic’s observation gets to the heart of what endlessly frustrating and fascinating about covering and following markets. Stocks go up. Stocks go down. All while the human mind demands there be some sort of explanation for this move. And saying, “it’s technical” just doesn’t have the same ring or force as saying the reason stocks are up or down is because of other humans.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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