15th January 2015
Psigma head of global equities Tim Gregory argues below that following the last few year’s superb run, he is now neither a bull nor a bear.
It has been a superb few years for US equities, helped by a very supportive central bank policy and shareholder friendly management, who are rewarding investors through dividend rises and share buybacks.
Such has been the unrelenting strength of the rise in stocks that the forward P/E Ratio for 2015 earnings is now 16 times for just 7% earnings growth.
This looks stretched, even with ten year bond yields now below 2% and even more so when earnings momentum is actually negative. Of course most of the negative earnings revisions come from the energy sector but in fact most sectors of the market have been downgrading forecasts in recent months, despite the strong economic growth that the US has been generating.
The other major culprit for this is the strong dollar – over 40% of the S&P 500’s earnings for 2014 came from outside of the US domestic economy. So there can be little doubt that the translation effect of the currency as well as weak European and other economies will be taking its toll on the profits of multi-national US corporates. This ought to be a real concern for US equity investors going forward.
The first earnings season of 2015 officially kicks off this week and we will no doubt see the usual array of previously downgraded companies reporting earnings ahead of expectations. This tactic seems to have become par for the course in recent years. However, the likelihood is that full year guidance will remain conservative, given the uncertainty in the world economy. The big question now is how stocks will react given stretched valuations after such a great run for stocks in the last few years.
So does this make us bearish of US equities? Not really, but we do think it will be a struggle for stocks to make much headway from this point. In fact, the US market could spend much of this year going up and down within a volatile range but ultimately end up flatlining.
In such an environment, stock selection will be absolutely crucial and there will be decent upside potential in companies that can continue to generate solid growth in earnings that justifies their lofty earnings multiples. This is especially true if bond yields remain low, which now appears to be a strongly held consensus view, then dividend growth will rightly continue to be very important and a strong driver for outperformance in a low return environment, which we also expect to be the case in 2015. Ironically this is the exact opposite of the majority of investors views from last year.