1st Quarter 2015: An Unsteady Beginning to the Year
The stock market limped to a pretty much flat finish in the first quarter as bad weather and a stronger dollar potentially impacted corporate earnings. The S&P 500 index, which makes up the largest 500 companies in the U.S., was up less than 1%.
1st Quarter Results:
We all know what the weather was like the past three months, especially in the northeast. Colder than normal temperatures impacted consumer spending which makes up 70% of the U.S. economy. This does not bode well overall for company earnings. The stock market rises and falls primarily on earnings and interest rates.
The soaring dollar is crunching profits at giant U.S. multinationals, prompting Wall Street analysts to make their deepest cuts to earnings forecast since the financial crisis. The dollar has jumped 12% against the euro in 2015 and 27% from a year ago. Overseas earnings represent 46% of overall profits for these large companies. As the U.S. dollar rises versus the euro, earnings earned overseas in euros get translated back into the U.S.
currency. A weaker euro means more euros are needed for each dollar. Thus foreign earnings in euros are worth less in the U.S. Since earnings drive stock prices, lower earnings put pressure on these prices.
The dollar’s surge against the euro has been driven by an aggressive European Central Bank monetary-easing program that has come as the U.S. central bank, the Fed, is preparing to raise interest rates. Analysts are predicting that profits at S&P 500 firms for the first quarter will show their biggest annual decline since the third quarter of 2009. Earnings are expected to fall as much as 4.9% in the first quarter.
On a brighter consumer note, the continued fall in the price of oil means we all have more money to spend elsewhere. Crude oil is down below $50bbl. when it was above $100bbl. just a year ago. Slowing consumption combined with overproduction has led to this startling situation. The downside is that it will affect oil company earnings. Oil companies make up about 8% of the S&P 500.
As of the end of March, the S&P 500 Index stands virtually unchanged from where it began in 2015. The path to this result has been anything but steady. In the past four months there have been six declines in excess of 3%, followed by five ensuing rallies of 3-6%. Pullbacks in excess of 3% have occurred every 14 trading days on average compared to the previous 20 months when similar pullbacks average only once ever 50 days. Clearly, there has been more volatility as the bull market has gotten older.
In the coming months, market volatility is likely to remain elevated and gains may be limited due to a plethora of headwinds facing the global economy. Yet, we feel the U.S. equity markets will overcome these challenges and achieve a higher level over the course of 2015. The main catalyst for this bullish stance is the strengthening U.S. economy.
Currently, the U.S. economy appears solid and should remain so as consumers reap the benefits of lower energy prices and an improving job market. In addition, economic conditions in Europe appear to be stabilizing and could surprise on the upside which would be positive for U.S. equity markets. At the same time, the guessing game regarding when the Federal Reserve will raise interest rates will keep the market jittery in the near term. With inflation under control, a slow and steady rate increase looks like the most likely path for the Fed. As long as the economy remains healthy, we believe equities will become conditioned to the new policy and move higher.
While corporate valuations are no longer low by historical standards, they are not a major headwind at this time. The recent price-earnings ratio is above 18 times which is slightly higher than the average of 16 times. In addition, however, earnings expectations are declining due to the rise in the U.S. dollar and weak energy prices. Consensus estimates have reduced expected S&P 500 earnings growth from 8.6% to 2.6% for 2015. While lower earnings may reduce the upside for equities, we feel there is potential for expansion of earnings’ multiple. We believe the slowing earnings trend is not based on deteriorating economic conditions, and that the variables contributing to this trend will eventually stabilize.
Oversupply in the energy market will likely be reduced through the next 12 months, helping to stabilize oil prices and increase oil company earnings. The U.S. dollar will settle into a range and companies will adjust hedging practices to help smooth the earnings trend. The risk of a higher dollar is demand destruction, mainly for overseas sales of manufactured products in the U.S. Yet, the benefits of lower energy prices and an improving job market will lessen the negative impact of exports on U.S. domestic product (GDP).
In summary, expect volatility to remain elevated in the near term as investors deal with a shifting global investment landscape related to diverging central bank policies, volatile currencies, falling energy prices and geopolitical issues. While these concerns may keep equities from soaring like they did in 2013 and 2014, they should not keep the market from moving forward slowly.
~Bruce A. Kraig, MBA
In this turbulent market, it is important that portfolios have good diversification with exposure to all sectors of the economy. During the first quarter, we primarily invested in large company mutual funds which remain the safest place to be in this turbulent market. As always, we keep a watchful eye on all markets and will move some equity mutual funds into bonds or cash if conditions warrant.
To discuss professional ongoing management of your portfolio, call us at 610-644-3468 for a complimentary meeting. Protect your valuable investments with a customized strategy to match your needs and risk tolerance.
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