• Home
  • About
  • 151 IMPACT AWARDS
  • Subscribe
  • Conference
  • Events Calendar
  • Webcast151
  • MOTB
  • Log In
  • Register

Room 151

Impact Awards –>
  • Treasury
  • Technical
  • Funding
  • Resources
  • LGPS
  • Development
  • 151 News
  • Blogs
    • David Green
    • Agent 151
    • Dan Bates
    • Richard Harbord
    • Stephen Sheen
    • James Bevan
    • Steve Bishop
    • Cllr John Clancy
    • David Crum
    • Graham Liddell
    • Ian O’Donnell
    • Jackie Shute
  • Interviews

James Bevan: Equities, go-go stocks and prospects for a bear market

0
  • by James Bevan
  • in Blogs · James Bevan · Treasury
  • — 7 Jan, 2016
James Bevan

James Bevan

Equity markets have started the new year wrong footed by several developments.

First, China’s weak December official manufacturing PMI (Purchasing Managers Index – compiled by the China Federation of Logistics & Purchasing) and the Caixan/Markit unofficial M-PMI renewed fears of decelerating Chinese economic growth.

The former wasn’t as weak as the latter, and the output component of the official measure remained solidly above 50.0 at 52.2, as it has since February 2009 but nevertheless, Monday’s 7% plunge in the Shanghai and the weakness in the yuan also raised alarm bells about China among investors.

The market reaction seemed to confirm that China’s economy is in serious trouble. However, the fall in stocks was exacerbated by fears that a ban on selling shares would expire on Friday. The FT reported “China is to extend a ban on stock sales by large shareholders until permanent rules to restrict such sales take effect, as authorities seek to calm market fears over the lock-up that was due to expire on Friday.”

There was more bad news from China. The Caixan/Markit NM-PMI fell to 50.2 during December, the weakest reading since July 2014. That suggests that the transition from manufacturing to services isn’t proceeding well. However, that’s totally at odds with the official NM-PMI, which rose to 54.4 in December, the highest since August 2014. Little wonder that China’s stock market is in a tizz.

State side

Then we have the US, where the economic outlook was wrong footed by December’s disappointing M-PMI, released on Monday, and slower auto sales for the last month of 2015, reported on Tuesday. On Wednesday, there was more bad news about the NM-PMI. The good news was that US auto sales totalled 17.4 million units last year, the best year since 2000 – but the bad news is that December’s annual rate dipped to 17.3 million from 18.2 million the month before.

It is hard to imagine that car sales can get much better, which means that the booming auto industry may not do enough to offset the bust in energy-related manufacturing. That would explain the drop in December’s M-PMI, compiled by ISM, to 48.2, the lowest since June 2009. The Markit measure of the US M-PMI remained above 50.0 at 51.2 during December, but that was a big drop from November’s 52.8 and the lowest since October 2012.

There wasn’t any good news in the ISM (Institute for Supply Management) and Markit measures of the NM-PMIs. Both fell in December, though they remained solidly above 50.0 at 55.3 and 54.3, respectively.

Meanwhile there’s nervousness on US GDP growth. The Atlanta Fed’s GDPNow model aims to forecast GDP by monitoring the same economic statistics that the Bureau of Economic Analysis uses in its initial estimates of GDP.

GDPNow is updated frequently by the Atlanta Fed as new data become available. Yesterday, the model projected that GDP grew by 1.0% (saar) during Q4-2015, up from Monday’s estimate of 0.7%, reflecting a swing in net exports’ contribution to Q4 GDP from a preliminary estimate of negative 0.2ppt to a positive 0.2ppt following yesterday’s trade report.

But it still remains below the model’s previous prediction of 1.3% on December 23, reflecting weak construction spending and ISM manufacturing numbers at the start of the week.

Then yesterday’s November merchandise trade report showed 1.1% month on month and 4.0% year on year drops in real exports.

In current dollars, total construction spending dipped 0.4%mom during November – the first decline since June 2014. While residential construction remains on an uptrend, non-residential and public construction have stalled in recent months.

World Bank

Also this week, the World Bank cut its global growth forecasts 2016 based on deeper contractions than expected in Brazil and Russia and meeker output in most of the world’s biggest economies, including the U.S. and China. The World Bank cut its forecast for global growth in 2016 by 0.4 percentage point to 2.9%, so only slightly higher than last year’s downward-revised growth rate of 2.6%.

In response to this deluge of new year’s bad news, a couple of Fed officials offered some delusional discussions of several rate hikes in 2016.

FRB-SF President John Williams on Monday told reporters: “I could easily see it be three or five or more or less depending” on what happens with the economy. But he noted that the median view of FOMC officials is four rate increases, saying that would leave the central bank overnight target rate at around 1.35%, which he said is “a reasonable guess” for what’s likely to happen.

In a CNBC interview, Fed Vice Chair Stanley Fischer echoed that four rate hikes would be “in the ballpark.” As Bloomberg noted on 4th January, in an article titled Fed Vice Chairman Fischer’s hawkish tone may have added to market angst: “On Sunday, Fed Vice Chairman Stanley Fischer said the U.S. central bank should be open, in the future, to raising interest rates to ward off potential asset bubbles. How much financial stability concerns should play in monetary policy remains an unsettled policy at the U.S. central bank. Prior to the crisis, the Fed’s leadership did not support hiking rates to ward off asset bubbles.”

Geo political

We also have geo-political challenges. North Korea claimed to have detonated an H-bomb and this comes hot on the heels on the Iran/Saudi tensions.

Typically geo-political disturbances are largely ignored by stock markets and mark downs are viewed as buying opportunities by investors but this year is widely expected to be fraught with more dangerous disturbances than usual, so markets are skittish.

Just as stock markets sank miserably during the first few trading days of 2016, pessimists had already prepared long worry lists for the year and added the plunge in Chinese stocks and heightened Middle East tensions this week.

Another item on everyone’s worry list is the pricing of equities, proxied by the US market’s price/earnings (P/E) multiple, which is widely viewed as historically high. And for sure the P/E is high, but there are different messages from the details.

Thus, the forward P/Es on six out of 10 sectors are lower today than they were at the end of 2014. The only sectors that saw a notable increase in their earnings multiples were Energy and Consumer Staples.

Here’s a list of sectors’ forward P/Es today and where they stood at the end of 2014: Energy (28.3, 16.9), Consumer Staples (20.1, 19.0), Consumer Discretionary (18.3, 18.2), S&P 500 (16.5,16.3), Tech (16.3, 15.7), Health Care (16.1, 17.0), Utilities (15.6, 17.3), Industrials (15.6, 16.1), Materials (15.5, 15.8), Financials (13.6, 14.2), and Telecom (12.5,13.4).

Go-go stocks

Two of the sectors with the highest multiples – Energy and Consumer Staples- don’t include any go-go stocks like Facebook, Amazon, Netflix, and Google, indicative of overheated valuations.

In fact, it looks as if it’s pessimism and not the optimism of an overheated bull market, that’s driving their multiples higher.

Thus with a forward P/E of 28.3x, Energy has the highest multiple among the 10 sectors in the S&P500. The sector’s multiple has soared as earnings have fallen sharply while the stock prices of energy stocks haven’t fallen as much. So the high multiple reflects depressed earnings expectations, not speculative excess. That said, the most expensive oil in the world may be in the US stock market given the Energy sector’s elevated P/E.

The Consumer Staples sector has the second-highest forward earnings multiple, at 20.1, even though it’s expected to grow earnings by only 5.4% this year.

Some industries within the sector, notably Brewers and Distillers & Vinters, became frothy as a result of the M&A boom but other areas have lofty P/Es mostly because they are in defensive areas with decent yields.

Household Products, for example, has a 20.9 forward P/E on earnings that are expected to decline by 2.1% this year. Likewise, earnings in the Soft Drinks industry are predicted to rise only 5.7% yet the forward P/E is 21.5.

Without these high-multiple sectors, the S&P 500’s valuation looks a bit more reasonable. Excluding the depressed Energy sector and the defensive Consumer Staples sector, the S&P 500’s forward P/E shrinks to 15.6 from 16.5.

Another sector with an outsized P/E is Consumer Discretionary, at 18.3, which might not be so bad given the expected earnings growth of 14.5% over the next year. This is one sector that is affected by go-go stocks, since it includes the Internet Retail industry, which includes Amazon and Netflix.

The Internet Retail industry, with a 60.6 forward P/E, has one of the highest multiples among the S&P 500’s industries, and it’s increased since end 2014, when it was “only” 45.3. However, earnings growth is expected to be 52.1% this year.

The impact of the go-go stocks shouldn’t be ignored. The S&P’s forward P/E would fall to 15.7 without the impact of just the four ‘FANG’ stocks and if we deduct the FANG stocks, the depressed Energy sector, and the defensive Staples sector from the S&P500 P/E calculation, the index’s multiple falls to 14.7. Thus the vast majority of stocks look much more reasonably priced than the broader index’s multiple would imply.

It’s way too early to assume that we are due and will have a bear market in the near term.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla

*CCLA is a supporter of Room151

Share

You may also like...

  • Printing money: not as straightforward as it sounds Printing money: not as straightforward as it sounds 24 Jan, 2013
  • Sovereignty trumps common sense at most councils Sovereignty trumps common sense at most councils 6 Jun, 2013
  • Mr Bernanke’s position in perspective Mr Bernanke’s position in perspective 31 Jan, 2012
  • The proposed changes to the LGPS: local valuation cycles and exits The proposed changes to the LGPS: local valuation cycles and exits 24 Jun, 2019

Leave a Reply Cancel reply

You must be logged in to post a comment.

  • Register to become a Room151 user

  • Latest tweets

    Room151 2 days ago

    Impact Awards: Cheltenham’s tech hub and Hackney’s recovery from cyber attack: The CCLA/Room151 Impact Awards spotlight  finance teams with a direct impact on their local communities and the environment. This week we explore Cheltenham Borough Council’s… dlvr.it/Rxg53h pic.twitter.com/iH8oGKOfSs

    Room151 3 days ago

    Collaboration the key to district recovery post-pandemic: Regeneration and economic growth will depend on districts’ ability to secure funding and work with public and private partners, argues Sanjiv Kohli. Covid hit us in March 2020 and immediately[...] dlvr.it/Rxb4VK pic.twitter.com/FiMynEQVPU

    Room151 1 week ago

    Impact Awards: Liverpool’s cafe culture and Warrington’s investment in homes: The CCLA/Room151 Impact Awards showcase  finance teams with a direct impact on their local communities and the environment. This week we spotlight Liverpool City Council’s… dlvr.it/RxJsKb pic.twitter.com/dEYpaz6HP0

    Room151 1 week ago

    Doing something in #localgov #finance for housing or regeneration? Check out the 'Place Shaping' category room151.co.uk/impact-awards/… sponsored by @31tenConsulting in the CCLA/Room151 Impact Awards. #timetoenter !! pic.twitter.com/dU99vE6Wws

    Room151 1 week ago

    Doing something in #localgov #finance for Adult Social Care & Health? Check out the ASC&H category room151.co.uk/impact-awards/… sponsored by Fundamentum Social Housing REIT in the CCLA/Room151 Impact Awards. #timetoenter !!

    Room151 1 week ago

    Doing something in #localgov #finance for the environment? Check out the 'carbon management' category room151.co.uk/impact-awards/… sponsored by @ACSLLP in the CCLA/Room151 Impact Awards. #timetoenter !!

    Room151 1 week ago

    So what are the seven categories for the CCLA/Room151 Impact Awards? Here they are room151.co.uk/impact-awards/… #localgov #finance #outcomes

    Room151 1 week ago

    Why should LGPS be concerned about rising inflation?: The impact of the coronavirus pandemic, lockdown and wider economic uncertainty created  deflationary pressures which raise important considerations for the Local Government Pension Scheme writes… dlvr.it/RxF7Fs pic.twitter.com/JlcjROBIpz

    Room151 1 week ago

    JOB ALERT: LPFA Finance Director vacancy: London Pensions Fund Authority Finance Director and s151 Officer Competitive salary and benefits The largest Local Government Pension (LGPS) provider in London with around £6.5 billion of assets and 135[...] dlvr.it/RxBdJP

    Room151 1 week ago

    Richard Harbord: Further signs that local government finance is failing: The crisis in Liverpool and a fix for education budgets are further indication that local government finance is in need of a root and branch review. Even for those students[...] dlvr.it/Rx9PSV pic.twitter.com/sAanC2gEyu

    Room151 2 weeks ago

    Impact Awards: Finance helps launch school meals company and support business during lockdown: The CCLA/Room151 Impact Awards will showcase the way finance teams have a direct impact on their local communities and the environment. This week we spotlight… dlvr.it/RwnlF4 pic.twitter.com/AJhne1MVG4

    Room151 2 weeks ago

    "This work has made a vital, practical contribution to ensuring people have been supported through the pandemic." #impact #151awards #covid #s151 room151.co.uk/treasury/impac… #impactcasestudies #councilfinancemakesadifference

  • Categories

    • 151 News
    • Agent 151
    • Blogs
    • Chris Buss
    • Cllr John Clancy
    • Dan Bates
    • David Crum
    • David Green
    • Development
    • Forum
    • Funding
    • Graham Liddell
    • Ian O'Donnell
    • Interviews
    • Jackie Shute
    • James Bevan
    • Jobs
    • LGPSi
    • Mark Finnegan
    • Recent Posts
    • Resources
    • Richard Harbord
    • Stephen Fitzgerald
    • Stephen Sheen
    • Steve Bishop
    • Technical
    • Treasury
    • Uncategorized
  • Archives

    • 2021
    • 2020
    • 2019
    • 2018
    • 2017
    • 2016
    • 2015
    • 2014
    • 2013
    • 2012
    • 2011
  • Previous story Agent 151: It’ll never happen … those predictions for 2016
  • Next story News Roundup: Disinvestment curbs, New Homes Bonus, spending power, Glasgow OBE, grant cuts admission

© Copyright 2021 Room 151. Typegrid Theme by WPBandit.