Shaping a portfolio for 2015 (vii): putting the pieces together

I expect 2015 to be a “normal” year, in contrast to the past six.  This is important.

Over the past six recovery-from-recession years, global stock markets have had a strong upward bias.  Yes, outperformance required the usual good sector and individual security selection.  But if “bad” meant up 12% instead of up 15%, most of us would be happy enough with the former.

This year, though, is more uncertain, I thin.  Whether the S&P 500 ends the year in the plus column or the minus depends on importantly on four factors:

–PE expansion.  Unlikely, in my view.  

–interest rates.   Arguably, rising rates may cause PE contraction, ash or bonds become more attractive investment alternatives to stocks

currency changes.  A rising currency acts much like an increase in interest rates.

profit growth.  In a normal year, earnings per share growth is the primary driver of index gains/losses.  It will be so for 2015, in my view.

Another point.  Four moving parts is an unusually large number.  There are other strong forces acting on sectors like Energy and Consumer discretionary, as well.  Because of this, unlike the past few years, where one could make a plan in January and take the rest of the year off, it will be important in 2015 to monitor plans frequently and be prepared to make mid-course corrections.

profit growth

Here’s my starting point (read:  the numbers I’ve made up):

US = 50% of S&P 500 profits.  Growth at +10% will mean a contribution of +5% to overall index growth

EU = 25% of S&P 500 profits.  Growth of 0 (due to euro weakness vs. the dollar) will mean no contribution to index profit growth

emerging markets = 25% of S&P 500 profits.  Growth of +10% (really, who knows what the number will be) will mean a contribution of +2.5% to             index growth.

Therefore, I expect S&P 500 profits for 2015 to be up by about 7% – 8%.

interest rates

The Fed says it will raise short-term rates, relatively aggressively, in my view, from 0 to +1.5% by yearend 2015, on the way to +3.5% by yearend 2017.  This plan has been public for a long time, so presumably at least part of the news has already been factored into today’s stock and bond prices.  What we don’t know now is:

–how much has already been discounted

–what the Fed will do if stocks and junk bonds begin to wobble, or emerging market securities fall through the floor, because rates are rising.  My belief:  the Fed slows down.

–is the final target too aggressive for a low-inflation world?  My take:  yes it is, meaning the Fed’s ultimate goal of removing the US from monetary intensive care may be achieved at a Fed Funds rate of, say, 2.75%.

My bottom line (remember, I’m an optimist):  while rising rates can’t be considered a good thing, they’ll have little PE contractionary effect.  Just as important, they won’t affect sector/stock selection.  The major way I can see that I might be wrong on this latter score would be that Financials–particularly regional banks–are better performers than I now anticipate.

If rising rates do have a contractionary effect on PEs, the loss of one PE point will offset the positive impact on the index of +6% -7% in earnings growth.  So the idea that the Fed will slow down if stocks begin to suffer is a crucial assumption.

 

currency effects

The dollar strength we’ve already seen in 2014 will make 2015 earnings comparisons for US companies with foreign currency asset/earnings exposure difficult.  Rising rates in the US may well cause further dollar appreciation next year.  Even if the dollar’s ascent is over, it’s hard for me to see the greenback giving back any of its gains.

Generally speaking, a rising currency acts like a hike in interest rates;  it slows economic activity.  It also redistributes growth away from exporters and import-competing firms toward importers and purely domestic companies (the latter indirectly).

The reverse is true for weak currency countries.  At some point, therefore, companies in weak currency countries begin to exhibit surprisingly strong earnings growth–something to watch for.

growth, not value

Typically, value stocks make their best showing as the business cycle turns from recession into recovery.  During more mature phases (read: now) growth stocks typically shine.

themes

–Millennials, not Baby Boomers

–disruptive effects of the internet on traditional businesses.  For example: Uber, malls, peer-to-peer lending.  Consider an ETF for this kind of exposure.

–implications of lower oil prices.  Consider direct and indirect effects.  A plus for users of oil, a minus for owners of oil.  Sounds stupidly simple, but investing isn’t rocket science.  Sometimes it’s more like getting out of the way of the oncoming bus.

At some point, it will be important to play the contrary position.  Not yet, though, in my view.

–rent vs. buy.  Examples:  MSFT and ADBE (I’ve just sold my ADBE, though, and am looking for lower prices to buy back).  Two weird aspects to this: (1) when a company shifts from buy to rent, customers are willing to pay a lot more for services (some of this has to do with eliminating counterfeiting/stealing); (2) although accounting for rental operations is straightforward, Wall Street seems to have no clue, so it’s constantly being positively surprised.

 

 

2 responses

  1. Hi.
    – Can u pls share ur views on EM markets? Do u think fund will flow back to EM again some time in next year?
    – Can u pls explain ur last point? i.e. rent vs. buy. I don’t understand this angle at all… Haha

    Thanks.

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