Earnings are expected to be better in 2016, and the market should start reflecting better earnings later this year.
- The U.S. has low inflation and that could help keep interest rates low. Low inflation gives the Fed more time and flexibility in raising interest rates. This is good for the economy and asset valuations. Every time there is confirmation that interest rates may stay low, the market has a strong rally.
- Low oil prices should be a net positive for the U.S. economy, especially for the consumer.
- Job growth is expected to continue in 2015.
- Shareholder perks like share buyback programs, spinoffs and dividend increases are expected to continue in 2015. There are signs that this trend is slowing, especially buybacks.
- From 1997 to 2012 the number of corporations publicly traded on American stock exchanges has dropped about 44%. Less supply could mean higher prices.
- Mergers and acquisitions and private equity companies buying companies are expected to be active and should help stock valuations.
- Central banks around the world have been pursuing stimulative efforts to help their economies.
- The market has been rising since 2009, longer than most bull markets. The slow growth from this economic cycle could cause this market cycle to last longer than the average, and could last at least another year.
The bearish case includes:
- Most of the risks to U.S. markets are external: Europe and Greece, China’s markets and their slowing economy, an unstable and uncertain energy rich Middle East.
- Earnings forecasts are coming down, especially for energy companies, and for companies that have significant sales internationally. The strong dollar makes U.S. goods more expensive.
Earnings are expected to improve by the end of the year, and into 2016. See forecasts below.
- The Fed may raise interest rates. Raising interest rates have been disruptive to the markets in the past, but less to the economy.
- Cyber-attacks could disrupt our economy and markets.
- The oil price collapse could cause some oil producing nations (Russia, Iran, Venezuela…) to take drastic measures. What measures they take is anyone’s guess, but desperate people do desperate things.
- Our Federal Reserve has very few effective bullets to use if we have a major financial crisis.
- Black and grey swan events. Events that have a low probability, but if they happen would have a big impact
Investors and analysts have low expectations for 2nd quarter 2015 earnings season.
As the list below shows, S & P earnings are expected to fall 4.5% for the 2nd quarter 2015.
Financials, Healthcare and consumer discretionary have the highest growth rates for the quarter and for 2015.
The dollar’s strength is hurting earnings for U.S. multinationals.
The collapse in oil prices is hurting energy companies.
Below is a list that shows the price increase/decrease year-to-date of the list of industries above.
Prices do reflect the expectations for earnings growth. The industries that are down only reflect 2015 price performance and not 2014’s. For example, oil and gas/energy is down about 10% for 2015, but most are down about 50% since their peaks last year. Energy’s price performance matches their earnings decline.
Utilities are down more than earnings, and that may be because the P/Es for utilities were above their historical averages earlier this year, in other words they were overvalued.
It’s good to look at the trend for earnings forecasts. Below are the weekly forecasts that come out in Barron’s each week.
Source: Barron’s and Dan Hassey database
By studying the spreadsheet, are earnings forecasts increasing, falling or flat? Prices are impacted by these changing forecasts.
2015 earnings forecasts were rising for about 1 ½ months, but then started to fall. Earnings forecasts have ticked up the last few weeks.
Earnings forecasts for 2016 have been essentially weak, and volatile, but higher than 2015.
Below are this month’s market forecasts:
Source: Consensus Earnings Estimates Thomson Reuters, Barron’s
As has been true for most of this year, the markets are fairly valued for 2015. If earnings forecasts are met in 2016, then the total return potential is about 10% (appreciation potential and dividend).
I have been warning that the market’s chart looks like it might be topping:
Most major markets have been going sideways since last December, about eight months.
Again, if earnings meet expectations, the Dow Jones could appreciate about 8% from current levels.
If earnings aren’t met, prices could roll over like they do at the end of a bull market.
Below is a chart of the end of the bull market of the 1990s:
The bull market of the 1990s topped at around 11,759 in late 1999 and finally broke down in 2002. The topping phase of the market lasted more than two years.
Once prices broke down in 2002, the market entered a bear market. From peak to trough, the market lost close to 40%.
We are seeing the transport index rollover:
Some of the transportation companies were overbought and overvalued.
The index has rolled over and is down about 13%, not bear market territory. The index may stay within in its trading range with support at about 8,000 and resistance is about 9,250.
We encourage caution, as the markets look toppy, valuations are fairly to overvalued, and there are external risks.