Having been fortunate to write for Jim Cramer’s “TheStreet.com” for about 10 years (I’m fairly sure Jim thought I was an idiot), being a small advisor the writing gig brought some small exposure as well as many life-long friends.
One article that still stands out was a piece written by an East Coast portfolio manager named Jeff Bagley, who I thought was a pretty good investor, and a good writer as well: he could make a persuasive case on stocks and sectors and did so many times. The article was written in the early 2000’s around the time of the technology bear market from 2000 through 2002, and was Jeff’s “George Costanza” opus, i.e. whatever his instincts were telling him to do, he was considering doing the opposite.
On gut feeling and instincts today, it is very easy to be bearish on 2016’s S&P 500 earnings and the expected returns, and because of that, I want to lean the other way.
1.) As was written this past weekend here, current 2016 earnings expectations are pretty subdued. If Energy just stays flat in 2016 or even rises 10% (Energy sector earnings) it is a win for the sector, and as the earnings blog post also detailed Apple’s (O:AAPL) EPS and revenue estimates are quite low for Apple’s fiscal 2016. (long AAPL, long some Energy, but still underweight the sector for clients).
2.) Thomson Reuter’s bottom-up EPS estimate forecast for 2016 as of last weekend, was $128.36. T/R’s 2015 bottom-up estimate as of last Friday was $118.26, for 8.5% expected growth next year. Howard Silverblatt of Standard & Poors as of last Friday, published his weekly earnings spreadsheet: sp-500-eps-est (silverblatt111315), here. Using the full-year SP 500 “operating earnings” estimates in Column’s I & J, beginning at line 126, the estimates are looking for 18% operating EPS growth next year, which even I think is too high. That being said, if the SP 500 grows operating EPS 10% next year, that would be an unexpected and pleasant surprise for sure. (Note the headline about operating income growth at the top of the spreadsheet.)
3.) The 3rd year of the Presidential cycle in terms of historical returns was predicting a strong SP 500 this year, but 2015 was not. Given the pattern of the SP 500 over the years, despite it being a Presidential election year, we are probably due an “above-average” year in terms of the SP 500 return. Here is the spreadsheet showing historical SP 500 and Aggregate / Treasury returns going back to the 1970s: FCSP500longtermdata From 2000 through 2014, the “average” SP 500 return, for that 15 year period, is still just 6% – that is below the long-term average.
What worries me about 2016?
1.) A Presidential election year where the rhetoric and the dialogue continues to escalate in terms of its nastiness. Intelligent debate went out the window years ago. Social media has only made it worse.
2.) Corporate credit: like SP 500 earnings, is dominated by Energy. Corporate defaults per Moody’s latest Leveraged Finance update, are expected to rise to 3.8% in ’16, but still below the long-term average of 4.6%. The SP 500 Energy sector earnings are dominated by Exxon (N:XOM) and Chevron (N:CVX), and it is extremely unlikely they will default, but Energy defaults could continue to create angst in the high yield market.
3.) Commodity deflation versus wage inflation: Jeff Miller had a good article on the topic last weekend on his blog here. I think the Fed actually wants to see a little inflation and Wal-Mart (N:WMT) is cooperating by boosting hourly store wages, and I would think Wal-Mart’s wage policies matter, since Wal-Mart is America’s single largest private employer. Can Wal-Mart in and of itself, have an influence on average hourly earnings or Core CPI wage and price data ? Not being skilled in econometrics, or even economic sampling, I can’t answer, but given Wal-Mart’s size you would think they would have to have an impact.
4.) Liz Ann Sonders of Charles Schwab (N:SCHW) wrote an article recently about Paris and the “Fed Policy Loop” and keeping the Fed on hold. The term “Fed Policy Loop” got my attention since it captured perfectly the merry-go-round we have been on since ’09 awaiting Fed hikes. ZIRP will end – that is a fact, since every trend in the capital markets does end at some point. I once thought a “1994 Scenario” would ensue for the SP 500, when Greenspan raised rates in early March ’94, the SP 500 fell 15%, bottomed and then re-tested later in 1994, only to rocket higher from 1995 to 2000. The problem is – looking at the spreadsheet above in terms of the long-term data, SP 500 earnings grew 19% in 1994. Most pundits think a Fed rate hike would initially hammer stocks. Without faster economic growth, without faster earnings growth, without a little inflation (all positives by the way) a Fed rate hike in the absence of all these metrics would seem to be more bad policy.
5.) Technically, the SP 500 has been range-bound for 12 months or since late November ’14. The SP 500 closed 11/28/14 at 2,068 and closed tonight at 2,083. That isn’t a lot of progress. The SP 500 needs to trade above the May ’15 and July ’15 highs of 2,132 and 2,134 and the sooner the better. Id like to see the NASDAQ Composite trade definitively above the March 2000 high of 5,132, and then stay there, and not drop back below like it did earlier this year.
6.) On this blog, the “year-over-year growth of the SP 500’s forward estimate” has been negative now for 6 – 7 months. That needs to change. A lot of it is the earnings drag of Energy and Basic Materials, which begin to lap easier comp’s but no question I would like to see the “forward 4-quarter growth rate” of the SP 500 estimate start to improve.
The three hallmarks of this bull market have been:
1.) General pessimism around expected future stock returns as evidenced by investor sentiment.
2,) General pessimism around SP 500 earnings.
3.) Greece, Ukraine, Venezuela, Ebola, China, and so on – the headline risk from around the world has dampened expectations and yet the SP 500 has pushed right through.
Expect +10% from the SP 500 in 2016 in terms of total return, and that might be light.
However, this is also a forecast which should be taken with an aircraft carrier of salt.
Thanks for reading.
Here is a quick sample of how client portfolios look:
Standard 60/40 equity/fixed asset allocation, with an overweight to equities given risk-reward and prospective bond returns.
Equity Sector weights: Technology and Financials largest overweight’s, given bear markets of 2000 through 2009. Replacing QQQ with QQQE over time to reduce Apple (O:AAPL) exposure. Industrials, Discretionary, some Staples, with small positions now in Energy and Emerging markets ETF’s in last 45 days,
Fixed Sector weights: Predominantly cash, with a 5% – 10% position in TBF, and utilizing Guggenheim Bulletshares more and more. Very underweight High Yield. Love muni’s even in taxable accounts, but muni high yield has very long duration. Out of muni’s almost entirely, despite attractive yield.
Top Equity positions: 1.) Microsoft (O:MSFT) (has been since 2013), 2,) Charles Schwab (SCHW), interest rate play, 3.) Amazon (O:AMZN) (solely from appreciation this year), 4.) GE (since Trian, added to almost every account, 3% dividend yield);
With Apple and biotech now lagging, the SP 500 could see some new sector leadership for the first time in a few years in ’16.