And now we are behaving hysterically at the prospect of just one? It’s a bit of a joke, really… We might have a wobbly few weeks when they do move, but I’m sure the Fed will stroke us like you wouldn’t believe and the markets will settle down, and most probably go to a new high.
-Jeremy Grantham on the Fed’s eventual first rate hike. (8/6/15) http://on.ft.com/1InJDDg
In May, I wrote that I was looking for a “5-15% multi-month correction to refresh the current bull market”. My cautiousness was based on a bull market that had not experienced at least a 10% correction in 3 years, a corporate earnings recession, excessively bullish sentiment, and deteriorating breadth..
Since then the market finally declined by a meaningful 14%. Also, the current decline in year-over-year S&P 500 earnings (by 14%), which can entirely be traced to both a strong US dollar and a collapse in energy prices, is likely to be the worst that we will see. According to the calculations of Thomas Lee, a Fundstrat Global Advisors LLC stock forecaster, the dollar’s rise this year has subtracted $10 per S&P 500 share. U.S. corporate profits would have grown by 8% without the impact of the strong dollar. Similarly, ex-energy S&P-500 earnings have grown 5% indicating that most US corporations are still prospering.
In fact, the past two years are among only four years out of the last thirty that the US dollar index registered double-digit declines. It would seem highly unlikely that the US dollar will continue to rise without taking a pause. Similarly, if the year ended today the price of light sweet crude oil would have suffered its third worst annual decline after 2008 and 2014 in thirty years. Again, it is highly unlikely for a major asset class to experience a massive move in the same direction for three consecutive years. On the other hand, if the US dollar and oil prices are stable in 2016 then earnings should resume its upward trajectory given the US economy’s decent growth.
|US Dollar Index||Oil (WTIC)|
If forward earnings estimates stop being cut, then the current PE multiple of 16 looks reasonable and in-line with the long-term average. But if the forward PE multiple is juxtaposed with historically low levels of interest rates, then there is a good chance that multiples can rise.
As seen in the following Investors Intelligence poll, the recent correction has erased the high levels of bullishness that existed during the past few years and has created excessive pessimism, which should also support equity prices.
Market breadth remains my only concern, though it was encouraging to see during Friday’s sell-off that breadth did not make a lower low.
My own expectation for 2016 is that the US dollar will be stable (+/- under 5%), oil will range between $30 to $60 per barrel, interest rates will be somewhat higher, US economic growth will pick up to 3%+, and the rest of the world will continue to be weak. Under such a scenario, I estimate S&P 500 companies to earn $110-120/share next year leading analysts to pencil in $130/share for 2017. If forward multiples rise to 17 or 18 to reflect receding worries of a US recession and a rapid tightening of monetary policy, then I believe that the S&P 500 can reach between 2200 to to 2350 next year.
According to Sam Stovall, a U.S. equity strategist at S&P Capital IQ:
“For 2016 I don’t see another flat year, nor would history say that flat years typically follow flat years. In fact, there have been 10 times since World War II in which the S&P 500 rose or fell by 3 percent or less. In the subsequent year the S&P 500 rose in price 80 percent of the time and posted an average annual increase of nearly 13 percent and was flat only once. We think that the S&P 500 will close 2016 at 2,250, representing a mid-to-high-single digit price appreciation.”
Given the market’s flat performance in 2015, the upper end of of my range, which corresponds to a high single-digit to double-digit percentage gain looks more likely. As I tweeted, my bullish outlook allowed me to get 100% invested near the bottom of the market’s decline last quarter. Although, I trimmed my position during the ensuing rally back towards the highs in expectation of turbulence as we approached the Fed’s first rate hike in nine years, the sell-off last week allowed me to rebuild a 90% long position.
Reducing net long exposure to 90% from 100% with $SPX at 1990.
9/16/15, 1:31 PM
Reducing net long exposure to 75% from 90% with $SPX at 2075
10/23/15, 10:16 AM
I bought near lows, believing this is not a bear mkt. But with $SPX just 2% below ATH I also think more time is needed before breaking out
10/23/15, 10:20 AM
Back to 90% net long at 2010 on $SPX. I believe bull market is ready to resume.
12/21/15, 4:09 PM
The closure of extraordinarily easy monetary policy has brought on the long awaited stock market correction. But, as opined by Jeremy Grantham in the quote at the beginning of this post, make no mistake about the Fed’s intentions: it remains the market’s friend. And once the market realizes it, the bull market will resume – it is only a matter of time!