For many months I have been growing more and more pessimistic on the outlook for the market over the near term for myriad reasons. I have articulated these concerns many times both here and on Real Money Pro; most notably in a piece entitled "Why the next correction could come in the first quarter" in early November.
This negative view is looking more and more on the money especially today as numerous Fortune 100 companies like Microsoft (MSFT), Pfizer (PFE) and Caterpillar (CAT) are submitting disappointing results and the monthly Durable Goods report is pointing to slowing growth.
One of the reasons the market has rallied over the last few months before hitting this latest "hiccup" to start 2015 is this was the year that the domestic economy was supposed to break out for what remains the weakest post war recovery on record.
Earlier this month the IMF revised up its estimate for U.S. GDP growth to an impressive 3.6% in 2015 while lowering their growth outlook for the rest of the globe. I have thought this forecast contained a lot of "hopium" since it came out.
It is just hard to fathom how the U.S. can grow at this prodigious rate in an environment of tepid global growth, collapsing oil prices, escalating geopolitical tensions, lack of a growth agenda domestically, etc. Investors who buy into this growth forecast are likely to be disappointed. They should also worry about three key things around equities at the current moment.
Earnings Estimates Falling:
There was a great piece by Jim Collins on Real Money today that is worth reading by anyone who is optimistic on the market right now. Mr. Collins goes through earnings estimates for FY2015 over the past nine months and shows how they have consistently come down even as the market has continued its steady rise higher.
In April, the consensus earnings forecast for 2015 called for 11.5% earnings year-over-year growth -- on sales growth of 4.4%. By October those forecasts had come down a bit and the overall earnings estimate for S&P 500 earnings in 2015 stood at just over $133 according to FactSet. In the roughly three months since these estimates have come down to just a shade over $123. Despite these downward revisions, the market staged a solid and traditional year end rally to close out 2014.
More worrying is that around 20% of those earnings are supposed to come from the distressed energy sector. Earnings estimates have come down significantly over the past quarter here but if oil stays around $45 a barrel, these forecasts will have to come down further.
Negative Impacts Of A Strengthening Dollar Becoming Apparent:
The other major negative for earnings is the strength of the dollar which seems to be accelerating in the New Year. The dollar gained more than 10% against both the yen and euro from June to the end of 2014. Since then, it has strengthened by more than five percent against the euro so far in 2015 as the EU has finally gone down the quantitative easing path.
I have been projecting that the euro could be heading to parity to the dollar over the foreseeable future over the past few months. This dollar strength is starting to show up in disappointing results and guidance from a variety of American multinationals which make up the core of the S&P 500.
You can best see the impacts of a strong dollar quite clearly in the results from chemical giant DuPont (DD) reported this morning especially in the forward guidance. The company guided to operating earnings of $4 to $4.20 a share in FY2015. This included a substantial 60 cent a share negative hit forecasted from the strong dollar. This is an approximate 15% cut to expected profits this year due to the strengthening dollar.
Now multiply those dismal results across every American multi-national that does significant business overseas. It is hard to make the case that earnings estimates for the overall market will not continue to fall despite the "tax cut" provided by falling gasoline prices.
Federal Reserve In A Bind:
Quantitative Easing domestically ended in October after more than five years of extraordinary liquidity support courtesy of the Federal Reserve. Investors may have forgotten the market lost one of its best friends recently as the market did not immediately fall out of bed when this long term support ended.
However, investors should keep in mind the huge correlation between the expansion of the Federal Reserve's balance sheet and the returns from the stock market over the past half-decade. No one should count on any new easing program even if the market goes into correction mode as it would ruin the Fed's credibility especially under a new chairperson.
In addition, the Fed is in a bind due to actions of other central banks. With the Japanese and European central banks continuing to pump liquidity into their markets, it is going to hard for our central bank to hike interest rates as planned even if we continue to see good growth in the economy and the jobs market. Doing so would strengthen the dollar even further and accelerate earnings impacts.
Due to this predicament, I expect conflicting signals from the Federal Reserve throughout the first half of 2015. This "Ying & Yang" Federal Reserve environment could sporadically cause additional turmoil in the markets as investors try to glean what the next course of action is for monetary policy.
Summary:
Given this outlook, I have assumed a defensive stance within my own portfolio. I am carrying a larger than normal cash balance which will be employed if we do get a significant pull back into the market primarily to large cap growth plays selling at reasonable valuations.
These Blue Chip Gems I plan to hold for 3-5 years so I don't mind not catching any near term bottom and feel very comfortable averaging into them. These include many names I write about frequently on Seeking Alpha including Celgene (CELG), Apple (AAPL), Gilead Sciences (GILD) and Las Vegas Sands (LVS).
