We at Guild Investment Management are bullish on the opportunities in the U.S. in 2015. We expect that a number of powerful economic and geopolitical tailwinds will drive higher U.S. GDP growth and corporate profits, and we expect the U.S. stock market to be higher in 2015.
This is said partly in jest… Why? We will drill down and look at the forces converging to support U.S. stock market performance in 2015.
Tailwind 1: Falling Oil Prices
Global oil prices have been in an accelerating decline since mid-June, and forecasters have been getting steadily more bearish, with some calling for oil to bottom in the $50 per barrel region. That would mark a more-than-50-percent decline from 2014’s high. We don’t know where oil will find a bottom, but we see forces converging to keep oil cheap for some time to come. That includes the ongoing rise of U.S. production; the faltering power of OPEC in the global marketplace; and the Saudis’ desires to put a crimp in U.S. shale, to arrange new long term sales arrangements with China, and to cause some pain to geopolitical enemies -- Iran and Russia.
This fall in oil prices is having, and will continue to have, dramatic effects on the global economy and global stock markets.
The world oil price fall is a huge benefit to the major oil importing countries. It’s the equivalent of a huge tax cut for the U.S. (and also for several other countries which we discuss below).
Tailwind 2: Cheaper Gasoline, Happier Consumers
In the case of the U.S., lower oil prices have already led to falling gasoline prices, fattening consumers’ wallets. Consumers with fatter wallets typically have better psychology, and consumers with better psychology support GDP growth and corporate profits -- especially in an economy where the consumer is in the driver’s seat.
Brent Crude Hitting Five-Year Lows After Several Stable Years its Decline
Tailwind 3: Steadily Improving Labor Market and Wage Growth
Consumers are getting the equivalent of a tax cut from lower gasoline prices -- you could call it a holiday bonus as well, since many consumers will look at it that way and direct their gas savings into discretionary purchases. That’s an immediate and near-term effect of cheaper oil.
However, looking beyond the shot in the arm of cheaper gas,fundamentals continue to improve for the U.S. consumer. The labor market has continued to strengthen, with headline unemployment (the U-3 measure) edging down. Maybe more importantly, the broader unemployment measure -- U-6, which includes those who only have part-time work even though they’d rather work full-time -- is making progress too, with the spread between U-3 and U-6 continuing to narrow.
The U.S. shale revolution has been a big engine of job creation over the past several years. Pressure on U.S. shale producers from lower oil prices will likely dial back the industry’s constructive role in employment. Even so, the recovery in employment seems to be broad-based enough to continue its progress, and the positive economic effects of cheaper oil will be far stronger than the drag created by a slowdown in the domestic energy sector.
November’s job gains were excellent, with October revised up strongly, and the labor market is poised to add more jobs in 2014 than in any year since 1999. Even better, November showed a 0.4 percent growth in average hourly wages. If we continue to see both of these trends into 2015, the consumer will be getting a durable improvement in her economic situation. As bullish as cheap gas is for the consumer, better wages are more bullish.
U.S. Wage Growth Closes In On Pre-Recession Levels: Liftoff Time For the U.S. Economy?
|Data Source: Bureau of Labor Statistics|
Tailwind 4: The Federal Reserve
Federal Reserve Chair Janet Yellen’s attention is focused on the health of the American worker and consumer. A tightening labor market and rising average wages might make observers think the Fed could raise rates by mid-2015.
We disagree. We think that the FOMC sees asymmetrical risks in raising rates. In short, in the committee’s mind, the risks of raising rates too early outweigh the risks of raising rates too late. Our reading of the FOMC’s psychology is that they would rather risk an overshoot in inflation than a derailment of the recovery. For this reason, we concur with the analysts who see a Fed rate increase in late 2015 or early 2016.
It is not just the U.S. Federal Reserve that is holding interest rates down to stimulate growth. Throughout the developed world, interest rates are at historically low levels. In certain countries, short-term interest rates are actually negative. These global low rates are helping to support U.S. equity market values as cheap money around the world looks for positive investment returns in a strong currency.
|Monetary Policy Remains Supportive in the U.S. and Around the World|
|Data Source: Bloomberg|
Cheaper oil adds weight to this analysis. Cheaper oil will give the FOMC more breathing room by dampening inflationary trends. That will make them more comfortable holding off on the first rate increase, even in the face of wage growth and continued strength in the labor market.
Tailwind 5: King Dollar
The U.S. Dollar bull story is still intact. With the end of QE from the Fed, the ramp-up of QE from the Bank of Japan, and the increasing prospect of larger QE from the European Central Bank (not to mention easing in many other countries), we see the trend continuing into 2015. The U.S. and China remain the best economic growth stories among the world’s major economies, and funds will flow into U.S. Dollar-denominated assets, looking for returns and protection from the decline in local currencies.
|The DXY Index -- Showing the U.S. Dollar Versus a Basket of Developed-World Currencies -- Recently Broke Out to Multi-Year Highs|
The Result: A Positive U.S. Stock Market Outlook for 2015
We foresee U.S. GDP growth of about 4 percent, which will help corporate profits grow by about 7 percent. Strong corporate profits, combined with low inflation and very low interest rates, will allow stock market valuations to grow slightly, causing a stock market appreciation of approximately 10 percent in 2015.
Of course, there are several important timing considerations for U.S. stocks:
1. Historically, stocks rise most from October to April. We anticipate that the U.S. stock market will continue to rise in the first quarter of 2014. We note also that stocks typically outperform in the third year of a presidential term, averaging an appreciation of 10.7 percent since 1900. 75 percent of third-year returns have been positive in that time.
2. Stocks rise most of the time before interest rates rise 1 percentage point from their lows. We do not expect interest rates to rise over 1 percentage point from their lows before early 2016. Thus, we expect the U.S. stock market to have a correction in about April or May 2015 when people discount a pending rise in interest rates. Such a decline will provide a buying opportunity until interest rates have risen over 1 percent.
3. Over the last two decades, every time that oil prices have fallen by 25 percent or more, the U.S. stock market has risen. This has happened 5 times, and all have seen stock market rallies. Several of those stock rallies were big (over 30 percent).
Because of all of the positive variables mentioned above, we anticipate that the U.S. stock market will rise in 2015. Stock prices reflect corporate profit growth, and as we have noted, we expect corporate profits to be up about 7 to 8 percent.
The U.S. stock market currently trades at about 17 times 2015 discounted earnings. We believe that the price-to-earnings (P/E) ratio will expand very slightly in 2015, and that profits plus P/E expansion will carry the U.S. market ahead.
Other Markets: Japan, China, and India
Japan, China, and India will also benefit from a combination of lower oil prices, weaker currencies, and stimulus by their governments and central banks.
The U.S. will not be the only attractive market. China, India, Japan, and other countries that are heavily reliant on imported oil will benefit by having a better import/export balance. Lower production and operating costs for their companies and their consumers will mean an expanded corporate profit structure leading to higher stock prices.
Markets outside the U.S. will also benefit from monetary policy. The Fed has concluded its QE program, but around the world, other central banks are either accelerating or initiating their own easing regimes. Japan has doubled down on QE, expanding its program and altering the composition of the government pension fund’s holdings to include more equities. Japan’s Prime Minister, Shinzo Abe, was elected with a promise to revive Japan’s stagnant economy with “three arrows” -- fiscal stimulus, economic reforms, and monetary easing. We’re beginning to doubt that there are really any other arrows except the last one, but we think that the Bank of Japan’s determination may still be able to accomplish a lot for the Japanese economy -- and for the Japanese stock market.
|The Bank of Japan’s Easing Has Driven the Nikkei to Multi-Year Highs|
The European Central Bank (ECB) continues to edge closer to buying Eurozone nations’ government debt. This would be in addition to the ECB’s current large, ongoing corporate bond-buying program. ECB policy is focused upon expanding economic activity in Europe.
China recently cut rates, and seems still to be in an easing phase, in spite of action this week which may have been aimed at curtailing speculative excess in the Shanghai and Shenzhen stock markets.
The Bank of India may have leeway to cut rates and boost markets if low oil prices constrain Indian inflation in 2015.
The countries we have mentioned may also be benefitted by having their currencies decline in value versus the U.S. Dollar, boosting exports and causing their corporate profits to expand even more. These markets should also do well in the early part of 2015. Of course, investors must hedge their currency risk when buying stocks in countries whose currencies they expect to weaken against the Dollar.
Investment implications: We are entering the new year with macro trends favoring the continued appreciation of U.S. stocks in 2015. Cheap oil, subdued inflation, rising wages, consistent GDP growth, strong corporate profit growth, a strong Dollar, and fund flows into Dollar assets create an attractive picture for the U.S. stock market. Other global markets may also be attractive as many central banks ease and stimulate, local currencies fall, and foreign corporations benefit from cheaper energy and better exports.
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