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December 28, 2015 at 09:29 AM
The stock market is looking fully valued, says Matthew Coffina, CFA, who edits Morningstar StockInvestor.
This means investors should get ready for “modest returns over the next five years,” he explains in an outlook piece on Monday.
“Market-timing has never been our game, but we can’t help but notice signs that this bull market may be getting long in the tooth: the Federal Reserve’s first interest-rate hike in a decade, a lack of market breadth, investors’ willingness to pay almost any price for fast-growing but unprofitable ‘story stocks,’ signs of trouble in the junk-bond market, and records or near-records in share repurchase activity and mergers and acquisitions,” he stated.
The Morningstar specialist sees earnings declining by 5% for the S&P 500 Index in 2015. Furthermore, it seems unlikely for dividends and earnings growth to support total returns above 6%-8% per year over the long run, Coffinna says. “Investors should set their expectations accordingly,” he cautioned.
“The market is increasingly driven by a handful of high-flying growth stocks such as Amazon.com (AMZN) and Netflix (NFLX), leaving more opportunities in out-of-favor cyclicals and value stocks,” he explained. “We believe investors are too pessimistic about certain apparel, energy and industrial companies, among others.”
Still, the S&P has been cheaper on a normalized price/earnings basis two-thirds to three-fourths of the time over the past 25 years, the CFA adds, meaning the prices are (too) high overall.
Poor Earnings, Value Plays
The S&P 500 may end the year near where it started, but earnings have been deteriorating, which pushes up valuation multiples, he says.
Some factors driving weak earnings include the strong U.S. dollar, weak commodity prices, slowing emerging-markets growth and recession-like conditions in several industrial areas of the U.S. economy.
Nonetheless, diverging returns between industries have created “a few areas of opportunity,” according to the Morningstar editor.
The consumer cyclical sector has posted strong year-to-date total returns, but apparel firms and lower-ticket discretionary retailers have fallen out of favor, he notes.
