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Outlook 2015: Seventh Year Stretch (Part 2)

In a continuation of last week’s blog outlining our 2015 investment outlook, below is a continuation of our forecasts for the coming year. The full report can be found on MarketScope Advisor (please visit www.getmarketscope.com to register for a free 14-day trial). To reiterate, S&P Capital IQ’s Investment Policy Committee sees the S&P 500 rising to 2250 by the end of 2015, based on an 8.6% rise in EPS and still-moderate inflation, though the prospects for higher rates should restrain P/E expansion. Despite the claim that valuations are stretched at 17.7X 2014E EPS, or a 1.4% premium to the quarter-century median P/E ratio, we think they are neither compelling nor off-putting. In addition, we see…

  • Rate-tightening cycle to start by mid-year: Indicators show that the U.S. economy no longer needs to be stimulated. Thus, the Fed will likely begin raising rates at its June meeting. Fed Chair Yellen will use the accompanying press conference to explain that the Fed is recalibrating monetary policy, rather than restraining economic growth.
  • Fed funds to close 2015 at 1.25% pushing the 10-year yield above 3.5%: Since 1953, the median monthly difference between Fed funds and the year-over-year change in headline CPI has been 1.6 percentage points. Today that spread is -1.6 points. The median spread between CPI and the yield on the 10-year note has been 2.5 points. Today, that spread is 0.6. We see these spreads widening closer to historical norms.
  • Favorable EPS Growth: U.S. earnings growth should continue in 2015. Capital IQ consensus estimates project an 8.6% gain in S&P 500 EPS, accompanied by a 4.1% rise in revenues. At 17.7X 2014E EPS, or a 1.4% premium to the 25-year median P/E ratio, we think valuations are neither compelling nor off-putting.
  • Lean toward cyclical sectors; Shy away from high-yielders: Defensive, higher yielding sectors, like Utilities, will likely be punished by the expected rise in rates.
  • Don’t bail out of bonds: In 1994, the Barclays Aggregate bond index posted its worst calendar-year performance since 1976 – it recorded a total return decline of only 2.9%. The Aggregate fell in just two other years over the past 39. We recommend an underweighting, but not a total avoidance, of this negatively correlated asset to stocks.

 

So, there you have it. We recommend that investors stay long, local, and lean cyclically. A global recession is not on the horizon, but we prefer U.S. equities to international ones. And though rates should rise, we suggest underweighting, but not avoiding bonds, the only negatively correlated asset to stocks. In all, we think the bull is alive, but prepare for increased kicking.

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