A Tumultuous Year Ahead

Wall Street’s S&P 500 Year-end Forecasts:

  • Federated Investors: 2350
  • RBC: 2325
  • Morgan Stanley: 2275
  • J.P Morgan: 2250
  • BTIG: 2200
  • Blackrock: 2160
  • Barclays: 2100
  • Goldman Sachs: 2100

Wall street firms polled by Birinyi Associates see the S&P 500 rising an average 8.2% this year as accelerating economic expansion and corporate earnings growth outweigh the detrimental effects from increasing rates. This comes after the S&P 500’s 11.4% gain and 53 record highs last year, extending the US bull market toward its 6th year anniversary this March.

Not one firm polled sees equities declining despite the Fed’s warnings of increasing volatility as they normalize rates. The Fed’s proclamation has already come true with VIX averaging 19.3 so far this year compared to last year’s average of 14.3. Despite higher volatility, stocks so far remain flat.

Studies show that stocks can continue to climb during the early stages of a tightening cycle (WSJ). Ben Carlson provides more detail in his Wealth & Common Sense blog, revealing that out of the 14 tightening cycles since 1950, in only 2 instances stocks lost value (bonds lost value half of these times). Furthermore in no instance was the rest of the globe embarking on massive QE while the US was normalizing rates, a situation that will offset any Fed effect (other than a strong dollar).

The dollar will continue to rally, fueled by the widening monetary divergence between the US and the rest of the world. Nevertheless any currency pressure on exports (13% of GDP) will be offset by low interest rates and oil prices. Depressed by an influx of foreign capital from the ECB ($68 billion/ month QE starting March) and BOJ ($60 billion/ month QE), lower interest rates will help US consumers (71% of GDP) in the form of lower borrowing rates, and corporation in the form of higher margins.

While the Fed has fixated on a June rate increase, international demand for higher yielding US assets will dampen the effect of the Fed’s rate hikes, holding interest rates low while boosting stock higher. TIC flow data (November: +$53.5 billion) already showed a record $6.112 trillion in Treasury bond held by foreign investors. Their insatiable demand will nearly create a bubble in US assets as long as their central banks keep printing money.

Equities are already pricey with the S&P 500 trading at 16.3 times forecasted earnings at the end of 2014 versus a historical average of 13.9 (WSJ & Factset). Similarly the index trades at 1.7x its expected sales this year, 31% higher than its 10-year average of 1.3. Nevertheless stocks will find momentum in earnings growth, forecasted at +6.3% for the full year which would be the best yearly performance since 2011 (WSJ).

Already pricey US assets temper Goldman Sachs PWM’s forecast to a 4.7% to 8.4% gain for the S&P 500 this year. Instead they recommend 2 foreign markets: Japan and Spain. Similarly Blackrock suggests cheaper Asian stocks like China and Japan (beware China’s margin levels).

Unfortunately strong economics correlates into stock performance worse than rainfall (Vanguard). While the US is a positive outlier economically, Barons reminds us of “the much heralded initial jobless claims numbers that hit a 14-year low last fall. That number also hit lows in June 1987, March 2000, and June 2007, which were all close to major market highs.” Beware for a precipitous decline in US stocks once the rest of the world stops printing money.

WSJ Monthly Survey of Economists

Faster job growth, consumer confidence (albeit volatile recently) and lower energy prices will boost US growth in the 3Q (+3.2%) and 4Q (+3%) this year.  Inflation adjusted consumer spending will grow 2.6% in the 2H this year, helped by lower energy prices (by 13bp in the 3Q and 21bp in the 4Q).

Oil prices are expected to close 2014 at $91.16, down $9 from June predictions. Inflation expectations are consequently lower, expecting annual CPI growth of 1.9% by year end.
Employment growth will average 214,000 over the next year, (227,000 current year average). Therefore unemployment will finishing the year at 5.8%, then finish 2015 at 5.4%.

The only headwind to growth lies internationally as Europe and Asia slow, while a stronger dollar curb US exports. That and some hesitation to higher interest rates… but higher rates only come when the economy is strong enough to support them.

THE TRADE (risk off) buy dollar, treasuries and sell Euro, Yen, commodities, small-caps and emerging markets.  Buy domestic large caps with little international exposure.  Dollar vs. Ruble looks perfect.

This just about sums it up.

An illuminating income and spending report last week:

August Personal Income & Spending: +0.3% & +0.5%. Both gauges rise as expected, given the strong August retail sales report (8/16/14 showing a +0.6% gain). Compared to last year, income (+4.1%) is outpacing spending (+4.4%), resulting in a little savings. Consumer prices were unchanged in August, leaving a very calm (+1.5%) annual gain that gives the Fed room to keep rates low. Core consumer prices gained (+0.1%) in August but also remained at a subdued (+1.5%) rate. Expansionary monetary policies in Europe and Japan will keep interest rates low, strengthen the dollar and keep inflation at bay.

CBRE February US, Europe & Asia Pacific Outlook

CBRE: US Europe Asia Pacific. Within the report divided into 3 continental regions, Asia-Pacific wins the 2013 outlook, primarily based on strong Chinese industrial production, bank loans fixed investment.  Exports from the smaller industrialized economies are growing as well, while Australia and Japan have more problems to deal with.

In the US, growth is expected to continue just like in 2012 with the notable changes confidence and housing.  Consumer confidence being the primary concern even though retail sales were robust last year  (4.7% overall, 4.4% ex-autos & gas).  Housing’s recovery can now be titled ‘sustainable’ while manufacturing is lagging and the service sector is doing rather well.

Obviously Europe is the worst of the 3 regions, and while confidence and manufacturing are at depressed levels, there is signs that the recession is bottoming out.  Still no sign on employment improvements however, that chart still goes straight down. The ratio of new orders to inventories hit a 11 month high, signaling a production rebound as demand from the US and China pull Europe form its malaise.

Stage Set For Budget Battles In Developed World

Natixis February Update.  Forecasting 2% growth for the US, 1% for the UK and Japan, and nothing at all for Europe, Natixis disagrees that world trade will be able to invigorate economic activity in the second half of the year.  There are 3 main hurdles for the US economy in the first half: the sequester, Continuing Resolution and debt ceiling.  All 3 of these will be dealt with at the very last minute.  The Continuing Resolution and debt ceiling must be dealt with or the US economy could see another downgrade, while the sequester is already priced in (they use lower multiples on government funded companes like healthcare and defense for example).  The sequester will take 0.5% off GDP, but looking at the actual BEA GDP report, government spending already took off 67bps in 2011 and 34bps in 2012.

The key in their European outlooks revolves around fiscal tightening in a recession, if that has a disproportionate impact on growth, and if world trade can help spur demand in the region.  They believe that the steep austerity measures, particularly in France, will lead to a deeper recession, while world trade will do very little.

Goldman Sachs 2013 Outlook

2013 Outlook Over the Horizon. Goldman Sachs sees interests rates staying low for a long time, despite having no nominal return for the foreseeable future.  They cite the 11.5 year period from 1939 when interest rates remained below 2.5%.  Cumulative asset class returns from 2009 are included, with 2012 showing continued growth in many sectors.  US Equity leads the pack form 2009 (+136%) while EM Equity led for 2012 (+18.6%).

Best investments for 2013 and 5 years out: EM debt, high yield debt, Euro Stoxx 50 equities and US bank stocks.  Hedge funds will have mid-single digit return, a wide-spread outlook.  They see a slight increase in world growth in 2013, led by emerging markets.  “Ongoing global growth should support earnings, providing a rising fundamental floor for equities.”  Page 10’s operating earnings vs. price chart says it all, stocks are incredibly undervalued.

Implied Total Return for 2013:

  • US equities:         1% – 6%
  • Euro Stoxx 50:     3% – 11%
  • MSCI EM:            7% – 12%