Barring a catastrophic event, financial markets in the second half of 2015 are expected to progress much like they did in the first half, although the momentum for bigger profits and market gains may be shifting away from the U.S. to overseas markets. That’s because the rebound in those economies and markets have only recently begun following changes in central bank policies that slashed interest rates and devalued currencies – policies that the U.S. had adopted years ago.
Following are highlights from ThinkAdvisor’s review of midyear outlooks from a variety of financial firms, including Liz Ann Sonders and Jeffrey Kleintop of Schwab and Bill Gross of Janus Investments:
U.S. Stock Market
The bull market in U.S. stocks is expected to continue, even though it’s now in its seventh year and almost twice as long as the average bull market. Strategists expect single-digit gains, though a 10% correction is possible along the way. (There hasn’t been one in almost four years.)
“Although we expect a rise in volatility and higher risk of pullbacks, we believe the bull market that began in 2009 – which we characterize as a ‘secular’ bull market – is not over,” writes Liz Ann Sonders, chief investment strategist at Charles Schwab in the firm’s midyear market outlook.
A major reason strategists expect just single-digit gains in U.S. stocks this year is valuation, which is on the rich ride. The S&P 500 is trading at a multiple that’s nearly 18 times trailing 12-month earnings, which tops the long-term post World War II average of 15 times by a pretty large margin, according to LPL. The price-to-earnings multiple based on 12-month forward earnings is 16.7 – well above the 10-year average of 14.1, according to FactSet.
After adjusting for continued low inflation and historically low interest rates, strategists appear less concerned about overvaluation of the U.S. stock market. “When one compares the P/E valuation [of the S&P 500] against the 10-year Treasury yield, we believe stocks appear meaningfully more attractive than Treasuries,” according to Wells Fargo’s 2015 midyear outlook.
Even Federal Reserve Board Chair Janet Yellen has said stock valuations are “not so high when you compare returns on equity to returns on safe assets like bonds, which are also very low,” but during that same appearance noted that “equity valuations at this point are generally quite high” and warned about “potential dangers.” That was on May 6, when the S&P 500 was trading slightly lower than it is today.
The U.S. Economy
“The most important piece for the bull market to continue is the absence of a recession,” according to LPL Research’s midyear outlook.
Economists are not expecting a recession in the U.S. but rather a pickup in growth in the second half to 3% or more following a negative first quarter (the last reading was -0.2%, up from -0.7% reported previously) and expected rebound in the second quarter. For the year, U.S. GDP adjusted for inflation is expected to range between 2% and 3%, and inflation is expected to be near 1.5%.
Underpinning the U.S. economy, according to Alan Levenson, chief U.S. economist at T. Rowe Price, are “a still-easy money policy, household sector deleveraging, low gas prices, wage growth and job growth” among other items.
The Fed and Interest Rates
Most strategists and economists expect the Federal Reserve will raise interest rates for the first time in nine years before the year is out and as early as September. Yellen and other Fed officials have suggested this many times but have also indicated that the rate increases will be gradual and begin when the data, according to the Fed’s latest policy statement, indicate “further improvement in the labor market” and the Fed “is reasonably confident” that inflation is moving back toward the Fed’s 2% target.
While Fed rate hikes are often considered a negative for stock and bond markets, strategists are not overly concerned about the early impact. “The direct impact of the Fed’s initial rate moves on the U.S. economy and corporate earnings is likely to be minimal,” write Chris Alderson and John Linehan in T. Rowe Price’s Global midyear market outlook. But they are concerned that the Fed’s “prolonged wait” to tighten may be have dulled investor awareness of the “substantial support that near-zero rates and historically low bond yields” have provided U.S. equity markets.
But Sonders at Schwab notes that since she expects the “the Fed to raise rates more slowly than it did in the past” — not at most consecutive policymaking meetings — the impact on the stock market will be limited.
Strategists and economists also expect that when the Fed raises rates only short-term rates, which the Fed essentially controls, long-term rates will fall or remain unchanged. This flattening of the yield curve supports long-term growth since many loans, such as mortgages, are tied to long-term rates.
Easy Money in Europe & Japan