They will rise this year, but not dramatically. \u00a0Early in 2013, when the Street was cautious, we expected \u201cvaluation levitation,\u201d which happened.\u00a0 Late last year we warned rising complacency would lead to higher volatility, but we stayed positive as investors \u201creach for yield.\u201d \u00a0\u00a0Volatility has indeed soared as momentum stocks collapsed.\u00a0 What next?\u00a0 Profits will rise 8-9% this year and so will stock prices, to around 2000 on the S&P 500.\u00a0 Most of the return will likely come in the fourth quarter, after Republicans do well in the November elections.<\/p>\n
Profits Will Be OK, Not Great<\/b><\/p>\n
I see no reason for either the U.S. or global economy to accelerate meaningfully this year.\u00a0 Economists continue to underestimate the negative impact of Obamacare on hiring (which, by the way, has not improved over the past two years). A friend of mine saw his monthly health insurance costs rise from $750 to $1,750, with higher deductibles; he is not unusual.\u00a0 And keep in mind the employer mandate has yet to be implemented. The NFIB small business optimism index remains in recession territory. Obama continues to resist pro-growth measurers such as the Keystone Pipeline and corporate tax reform.\u00a0 His push for a big hike in the minimum wage discourages hiring.\u00a0 But capital spending may pick up modestly; for example, truck orders look fairly strong.<\/p>\n
Globally, the main positive is that Europe, a key market for U.S. multinationals, is growing rather than shrinking.\u00a0\u00a0 But let\u2019s not exaggerate the improvement; France and Italy are stagnant, and the banking system still needs to de-lever. (Europe lags the U.S. by five years in this department.) The key emerging market, China, is slowing and many others have political \/ economic problems that retard growth (e.g., India, Brazil, Venezuela, Egypt, Turkey, Russia,\u00a0Thailand).<\/p>\n
Against this tepid economic backdrop, with profit margins are at all-time highs, a major positive profit surprise is improbable.\u00a0 We look for SPX EPS of $119-$120 in S&P 500, which is roughly the top-down consensus.<\/p>\n
The Message from the \u201cEarly Reporters:\u201d Fairly Positive<\/b><\/p>\n
They were mixed but not bad.\u00a0 We saw good or in-line results from Paychex, Fastenal, Cintas, Monsanto, Micron, Kroger, General Mills and ConAgra.\u00a0 JB Hunt, a major trucking firm, posted solid 9% revenue growth.\u00a0 \u00a0Poor results from Bed Bath & Beyond and Family Dollar partly reflect bad weather and vulnerable business models.<\/p>\n
More worrisome were poor results in the two most important \u201cswing factors\u201d for profits\u2014big energy and big banks.\u00a0 Chevron preannounced soft results; big oil is spending oodles of money but not finding much oil.\u00a0 JP Morgan, particularly its FICC division, is being hit by tougher regulation; Wall Street analysts have done a poor job\u00a0assessing just how much Dodd Frank will weigh on profits as compliance costs rise, trading revenue slows, and balance sheet leverage declines.\u00a0 I will be interested to see Goldman\u2019s Q1 results.\u00a0 (Wells Fargo\u2019s Q1 was better than JPM, with 4% loan growth.\u00a0 But the beat was low-quality.)<\/p>\n
Thirst for Yield Supports Equity Valuations<\/b><\/p>\n
Janet Yellen is a full-feathered dove.\u00a0 Even if rates do start to rise late next year money market funds\u2019 average return in 2016 will probably be less than 1%<\/b>.\u00a0 Meanwhile, bonds are expensive and risky.\u00a0 So large-cap stocks are attractive for yield-oriented investors.\u00a0 SPX DPS growth has average 15.5% over the past three years; with the payout ratio still low at 32%, dividends will probably grow 15-17% this year.\u00a0 (The 2013 comparison is easy because some firms accelerated dividend payments to Q4 2012, before tax rates rose.)\u00a0 The S&P 500\u2019s current yield on 2014 DPS is 2.2%, but it is easy to assemble a portfolio yielding 3-4%.\u00a0 \u00a0Investors\u2019 thirst for yield should keep the trailing PE on pro forma EPS about where it was at the end of last year, 16.8x, implying a year-end price of 2000 (16.8* $119 = 1999).<\/p>\n
History Strongly Suggests Most of the 2014 Return May Come in Q4<\/b><\/p>\n
Stocks should act better over the next month as attention turns from downbeat \u201csentiment\u201d about high-fliers to decent \u201cfundamentals\u201d revealed in Q1 profit reports.\u00a0 Even if Q1 earnings are not great, managements will highlight improving demand in March and April (as Fastenal, an industrial bellwether, did). That said it may take a while for investors to digest the demise of momentum stocks.\u00a0 Before long we will be in the August doldrums, followed by the pre-election jitters in September and October.\u00a0 So stocks may not do much in Q2 and Q3 and then perform well in Q4 following a strong Republican showing in the election.\u00a0 There is a very pronounced tendency<\/b> for stocks to be strong in the fourth quarter of mid-term election years.\u00a0 Consider:<\/p>\n Obviously, past may not be prologue. Unexpected events may intrude.\u00a0 But in current circumstances the historical norm seems very relevant.<\/p>\n Copyright Thomas Doerflinger 2014.\u00a0 All Rights Reserved.<\/p>\n","protected":false},"excerpt":{"rendered":" They will rise this year, but not dramatically. \u00a0Early in 2013, when the Street was cautious, we expected \u201cvaluation levitation,\u201d which happened.\u00a0 Late last year we warned rising complacency would lead to higher volatility, but we stayed positive as investors … Continue reading \n