The FAI 3Q 2015 Investment Outlook Continued
Yield on 10-year U.S. Treasury Bond past 3 months from Chicago Board Options Exchange
The following chart from dshort.com helps us see the historic relationship between the Fed Funds “zero-bound” rate, the periods of Quantitative Easing and the direction of stock prices.
Near term, the Fed’s decisions will be the main influence on U.S. bond prices; we continue to think that no matter when they make their first move, they will elevate very, very slowly.
World-wide, we think the perception of credit risk is the biggest variable… followed by currency issues. We’re not bullish on either. The 10-year German bund yields 0.65% compared with 2.2% for the U.S. version. For European investors who expect a weaker Euro ahead, the U.S. yield advantage with a currency kicker may well be irresistible. That’s why we include a modest position in 10-year Treasuries to augment our otherwise short-maturity bond portfolio.
Abroad, we won’t hazard a guess as to how things will sort themselves out except to say we think foreign bonds are an unattractive asset class due to uncertainties. So what about stocks?
Outlook for Stocks
Stock prices are usually most influenced by the outlook for corporate earnings. According to FACTSET, second quarter S&P 500 earnings are estimated to have dipped 4.5% year-over-year. The main villains: a lower oil price and strength of the dollar versus foreign currencies. But for the strength in other sectors, these could have caused an estimated 12.6% quarterly earnings decline. Consensus estimates for all of 2015 are for S&P 500 operating earnings of about $119 a share, up 5.3% year-to-year… all of the gain coming in the fourth quarter.
Squinting into the forecasting fog of 2016, consensus analysts’ estimates call for a 12% boost in S&P 500 profits. This seems quite optimistic to us since a) we see only about a 4% nominal GDP growth next year, b) U.S. wages are picking up (connoting pressure on currently high profit margins), c) energy sector earnings may be no better than flat, and d) the dollar’s uptrend against currencies in Europe, Japan and China could well persist, since the central banks in those regions are in brisk monetary ease mode while our Fed seems committed to boosting interest rates. U.S. stocks remain historically dear, yet, because global capital may flow toward America, our U.S. equity allocation is only modestly defensive… for now.
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