Bull market for stocks keeps on going in 2014

31 Dec 2014 | Author: | No comments yet »

After 2014’s party, investors in U.S. stock market may face a hangover.

Headed into the last trading day of 2014, the S&P 500 has gained nearly 13 percent on the year, shaking off concerns about valuations thanks to improved economic growth and a very accommodative US Federal Reserve. However, the S&P 500’s forward price-to-earnings multiple – based on 2015 earnings expectations – is at about 17 now, exceeding the 15-year average of about 15.

With the Fed ready to begin raising interest rates for the first time in a decade, and the strong dollar providing a headwind for companies with overseas operations, a lot will depend on whether the recent strong growth in domestic demand can drive corporate profits higher than those estimates. Whether consumers and companies benefit enough from lower oil prices to more than offset the effects of the slide on the energy sector is also critical. “Multiples almost always go down when the Fed raises rates – you’re going to have to depend on earnings,” said Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, which has $345 billion in assets under management. Since 1940, such a level is associated with S&P returns (excluding dividends) of about 5 per cent over a 12-month period, according to data from Citigroup. The S&P 500’s forward price-to-earnings ratio sat at about 13 times at the beginning of 2013; it is now closer to 17, according to Thomson Reuters data. Stocks have been noticeably more volatile in the last few months; the CBOE Volatility Index, or VIX, has averaged 15.4 over the past 12 weeks, compared with 12.6 at the end of August.

If the Fed tightens, the higher rates will not only raise financing costs generally but would also be a deterrent to borrowing to do the share buybacks that have helped to propel earnings per share growth and stock prices gains in the past few years. Europe is expected to grow at just above 1 percent in 2015, according to Reuters data, Russia has been slammed by oil’s decline, and China and other major emerging markets are struggling with weak demand as well. Citigroup’s chief equity strategist Tobias Levkovich, in a note on Tuesday, said estimate cuts in the next few weeks, when companies typically warn if they expect to report disappointing results, could lead to some reversals and volatility, as “some of the late 2014 S&P 500 gains appear to have been borrowed from 2015’s returns,” he wrote.

So far in the fourth quarter, expectations have fallen largely due to the energy industry’s woes, but sectors that could benefit from lower fuel costs, particularly the consumer discretionary sector – which includes many retailers – have not seen an attendant pickup in expectations. In the summer through the fall the market went nowhere, and the market at its bottom in October was unchanged for the year,” said Dan Greenhaus, chief strategist at BTIG LLC in New York. “The question is whether the general environment is supportive of higher stock prices, and the answer is still yes.”

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