James Bevan: realism not pessimism
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James Bevan
It’s true that we have been relatively downbeat of late in terms of equity market return prospects.
The increasing consensus is that stock valuation multiples may be too high given that the consensus outlook for earnings growth is lacklustre.
However, the whipsaw corrections last summer and at the beginning of this year suggest that trading this market is too difficult, and getting back into stocks at the right time can be just as tricky as getting out at the right time.
Bellwether
Focusing on US equities as the bellwether of equities overall, the S&P500 peaked at a record 2130.82 one year ago, on 21st May 2015, and as of Friday’s close, it’s down 3.7% from that record high.
While these flat market trends suggest that not much has happened over the past year, there has been significant volatility on occasions, which could certainly recur.
Photo: GotCredit, Flickr.
But the S&P500 can certainly remain at around 2000 points in 2016 before rising to new highs next year, reaching perhaps 2200-2300 points, assuming that the economy doesn’t fall apart.
In terms of intra-market turbulence, while broad stock market averages are basically unchanged on a year-on-year basis, there have been significant winners and losers at a sector and industry level.
Thus since 21st May 2015 sector returns for the S&P500 have been: utilities 8.1%, consumer staples 5.2%, telecommunication services 2.8%, consumer discretionary 1.0%, information technology -2.7%, industrials -2.9%, S&P500 -3.7%, financials -6.6%, health care -7.3%, materials -9.5%, and energy -16.0%.
Defensive stocks have outperformed cyclical ones, though the former gave back some ground to the latter since the latest relief rally that started on 11th February this year.
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8th Local Authority Treasurers Investment Forum
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Almost all of the price volatility in the S&P 500 and most of its sectors and industries over the past year has been attributable to their forward P/Es rather than their forward earnings, which are unchanged for the S&P500 over the past 52 weeks, with very little variability.
Forward P/E multiples for the S&P500 sectors were relatively high a year ago and they are about the same now. Health care has dropped the most year-on-year, and just three sectors are higher, with energy nearly doubling as forward earnings have tumbled.
Here is the P/E performance derby for the S&P 500 sectors now compared to a year ago: energy (48.5, 26.5), consumer staples (20.7, 19.4), consumer discretionary (17.5, 18.7), utilities (17.5, 15.8), materials (16.7, 17.0), S&P 500 (16.6, 16.9), industrials (15.9, 16.2), information technology (15.7, 16.0), health care (14.9, 17.2), financials (13.5, 13.9), and telecommunication services (13.4, 13.4).
Who’s buying?
As to who’s been buying equities, corporate finance activity has been a significant source of funds for the stock market with S&P500 buybacks and dividends rising to a record high of $954bn last year, and importantly, US companies stepped in to support their shares during the market upset at the start of the year, making the first quarter potentially one of the biggest ever for share buybacks.
Based on preliminary S&P/DJ data, share repurchases are 20% higher in Q1 2016 vs Q4 2015, and 31% above Q1 2015.
Among the biggest buyers of their own shares were Apple, General Electric, McDonald’s and Boeing, while ExxonMobil significantly cut its share repurchases on the back of the weaker oil price.
Meanwhile, US companies continue to sit on a lot of cash – Moody’s reckon that Apple, Microsoft, Alphabet, Cisco and Oracle had $504bn of cash by end 2015, with a total of $1.7tn held on balance sheets of US non-financial companies, and the top 50 holders accounted for $1.1tn of that amount.
Cornerstone
As for M&A activity, apart from a drop in Q1, there’s been a boom, which may well continue so long as bond borrowing rates remain low.
The Fed did end QE in October 2014 and hiked rates in December 2015. But tightening was put on hold after global financial markets rioted at the beginning of the year when a couple of Fed officials predicted four rate hikes in 2016.
Whilst the April FOMC minutes released last week suggest that normalization may resume at the June meeting of the committee, the detail reveals that while many “participants” favoured this move, the actual voting “members” of the committee were not as widely in agreement.
Meanwhile, no matter what the Fed does in June, the European Central Bank will start buying corporate bonds next month, and the US yield curve has been flattening with the fall in borrowing rates in Euroland and Japan causing US companies to raise more funds overseas. Foreign investors are scrambling to buy more bonds in the US.
The prospect of low bond yields, some growth and supportive central banks means that we should not panic and equities remain a sensible cornerstone of any long term strategy focused on achieving decent real returns.
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
Photo: GotCredit, Flickr.
