We do not believe that the market is significantly overvalued as some have suggested. Our analysis suggests that the market is actually either slightly overvalued or near fair value from a historical standpoint. According to Bespoke Investment Group, the average reading of the Price/Earnings Ratio (P/E) of the S&P 500 for the time period starting in 1989 and ending in 2014 was 18.90. Looking at a shorter time frame, the P/E of the S&P 500 for the time period starting in 2004 and ending in 2014 was 16.95. The S&P 500 closed the year of 2014 at 2,059 with a consensus earnings estimate for 2014 of 117.02. This equates to a P/E of 17.6, just slightly above the 10-year average of 16.95 but below the 25-year average of 18.9. Looking forward, the median forecast of Wall Street Strategists for 2015 S&P 500 earnings and the closing price of the S&P 500 are $126 and 2,213 respectively according to Business Insider. This equates to a median forecasted P/E of 17.6 for 2015, which interestingly is the same level where it is expected to be at the end of 2014. Hence, valuations are not currently anticipated to become richer, or cheaper, over the course of the New Year and are arguably reasonable from a historical perspective.
As a result of these valuations, in addition to a solidifying economic foundation in the U.S. and an improving jobs market, we believe that the U.S. stock market will continue to build upon its secular bull market rally in 2015, and post a positive return, potentially even in the high-single digit range, for the year, though there will likely be several more periods of short-term volatility over the course of 2015.
Here is a current summary of our eight (8) key forecasts for 2015 based upon data available to us and subject to change based upon any worldwide events that are not known at this time and cannot be planned for with any degree of confidence:
The U.S. economic recovery will continue, and perhaps pick-up some speed, with annualized Gross Domestic Product (GDP) growth likely in the range of 2.6%-3.0%. This will allow the U.S. to retain its status as "the shiny city on top of the global economic hill" in 2015.
- The U.S. stock market will advance upon its secular bull market run with an annualized gain in the range of 5%-9%. As a point of reference, according to Gold-Eagle.com, there have been seven previous periods identified as secular bull markets from 1815-2008 with an average length of 14.7 years. To contrast, the current secular bull market which started in March of 2009 is just under 6 years long thus far.
- Europe will continue to struggle with respect to its own economic recovery though its stock markets will see intermittent periods of appreciation due in large part to expected stimulus measures from the European Central Bank (ECB).
- Returns in Emerging Markets, a few of which, such as India, have economies that appear to be poised for significant growth in 2015, will be restrained by global economic difficulties at least for the initial stages of the New Year.
- Despite somewhat of a lackluster housing market, REITs will continue to perform, with certain REIT sectors performing better than others, as the economy grows and in spite of rising interest rates. To this end, it is important to recognize that REITs are not just related to the housing market and all REITs are not Mortgage REITs. In fact, the largest component of the REITs market is not associated with Mortgage REITs, but rather is associated with Retail REITs. Other sectors of the REIT market include diversified REITs, industrial REITs, hotel and resort REITs, office REITs, residential REITs, health care REITs and specialized REITs - including self-storage facilities. Certain REIT sub-industries appear to be positioned well to perform in a rising rate environment for the next few years under the presumption that the Federal Reserve would not consider raising interest rates unless it believed that the U.S. economy was on a firm footing and expanding moderately well, even if the housing market is not growing as rapidly. Additionally, REITs have demonstrated that they have performed well during previous periods where the Fed has gradually raised interest rates (Ex. 2004-2006), which is the path we believe that they will follow this time around (see forecast #7 below).
- Oil prices will remain at depressed levels, perhaps dipping into the $40 a barrel range, earlier in the year but start to return to more "normal" levels during the second half of 2015. This will allow the U.S. to continue upon its energy independence initiative and help those companies (Ex. fracking, infrastructure, MLPs, etc…) contributing to the growth of the energy sector.
- The Federal Reserve will likely embark upon its measured, drawn out tightening phase with a 25 Bp (i.e. 0.25%) hike in the spring of 2015. In this regard, we believe that the Fed will raise the Fed Funds Target Rate between 75 Bp-100 Bp by the end of 2015 and arrive within the range of 2.50%-2.75% by the end of 2016.
- We do not believe that it is a foregone conclusion that the yield on the U.S. Treasury 10-year note will rise above 3% in 2015 as some are suggesting due to the expected market volatility in 2015 that could continue to attract investors to the safe haven of U.S. Treasuries in addition to the slow pace of tightening on the part of the Fed that we anticipate with respect to interest rates (see forecast #7 above).
Investors will need to challenge themselves going forward in this particular cycle to be very selective in terms of finding additional pockets of risk-adjusted return possibilities across a wide range of asset classes and sectors. Given the many moving pieces in the complex, global investment puzzle, investors would be wise, in our view at Hennion & Walsh, to re-visit their asset allocation strategies to help ensure that they have the diversification in place to withstand potential periods of heightened volatility as well as the breadth of asset classes and sectors to help deliver risk adjusted growth opportunities. Perhaps the most interesting story to watch in 2015, which could have the biggest impact on economic and market growth, will be the price of oil, as opposed to the timing of interest rate hikes, and the growing likelihood of U.S. energy independence in the near future.