VOL. 130 | NO. 122 | Wednesday, June 24, 2015
The Worldly Investor
Money & Markets Around the World
DAVID S. WADDELL | Special to The Daily News
On central bank policy: At an early press conference, Janet Yellen quipped that the U.S. Fed might initiate rate hikes six months after QE, corresponding with March of 2015. She has been backpedaling ever since.
However, she instigated a strong U.S. dollar regime that has exported economic and earnings growth to Europe and Japan. The European Central Bank and the Bank of Japan will maintain their QE programs to enhance these gains. The Fed will likely “beta test” raising rates with one hike before year-end to save face. However, any further rate hikes will arrive intermittently unless forcibly required.
On the U.S. market: The U.S. rally is growing gray. Valuations are currently fair-plus at 17-18x earnings. The combination of a rising U.S. dollar and rising rates will tax earnings growth. Full-year estimates for 2015 are for 2 percent earnings growth despite a 2 percent decline in revenues. Likewise, 2016 earnings are projected to be 12 percent higher despite only a 6 percent rise in revenues. Therefore, analysts expect sizable profit margin expansion in 2016 despite rate and currency gains. We are more skeptical.
On the developed international markets: Japan is benefiting from the “Abenomics” policy regime. As a consequence, the weak yen and the potential for governance improvements make Japan investable at 15 times earnings.
Europe is benefiting from “Draghinomics”… another soothing stimulus story. Thanks to the weak euro, earnings and economic estimates in Europe are actually rising while ours are falling. At 15x forward earnings, Europe is also investable.
On the emerging markets: Valuations across the emerging markets are still compelling at 12x forward earnings. However, we have seen emerging market equities sell off recently as U.S. interest rates have risen. We witnessed a similar automated sell during the “taper tantrum” of 2013, but this pressure wore off as the growth, valuation, and earnings story resumed. I don’t think emerging markets are as fragile as they have been. If the global economy grows, emerging markets should perform well … especially given today’s low expectations.
On markets overall: Markets should continue to trend sideways to higher thanks to continued global quantitative easing. There is some potential for a downside surprise, as risk markets acclimate to rising rates. In our opinion, the VIX (stock market volatility measure) seems too low with currency and fixed income volatility high. This gets resolved through either a decline in volatility outside of the stock market or a rise in volatility inside the stock market. Should it be the latter, we would use a technical selloff to increase our offensive wagers as we do not see a recession on the horizon. Recession will cause the next bear market, not the initiation of rate hikes. We believe we are likely at the later midpoint of the cycle, not the endpoint.
Bottom Line: The market’s next test will be second-quarter earnings season, which begins mid-July. Should earnings underwhelm, as we expect they will, the probability of a September hike will diminish, adding continued support for stocks.
David Waddell is president and CEO of Memphis-based Waddell & Associates.