Today I’ll try to put numbers to my guesses about growth around the world next year. I think the best way to do this is in two steps, first without trying to factor in what I think will be a negative influence from natural resources industries, and then making both economic and stock market adjustments for them in a second round of analysis.
We’re likely to have trend growth in the US next year, meaning a total of +4% expansion, consisting of +2% real and + 2% inflation. Because publicly traded companies are typically the best and the brightest, this will probably translate into +8% growth in earnings.
Let’s say that Fed interest rate rises have little net effect on growth and that the dollar has peaked (meaning that headwind is gone). This may be a bit too optimistic.
I’m guessing that, unlike the past couple of years of aggressive share buybacks, we won’t companies retire more shares than to offset the issuance of new ones to employees through stock option plans. Therefore, 8% earnings growth will translate into +8% growth in earnings per share.
Given that half the earnings of the S&P 500 come from the US, this means the domestic contribution to S&P 500 earnings growth will be +4%.
The EU is maybe two years behind the US in recovery from recession. But it has clearly turned the corner and will grow in 2016. It also has the tailwind of substantial currency depreciation behind it, and the strength of Greater China and the US, major export customers.
Europe is also a substantial beneficiary of the fall in energy prices, although that plus is tempered a bit by the weakness of the euro against the dollar.
For all these reasons, the EU will likely enjoy above-trend growth next year.
Let’s say that the EU will expand by +2.5% real, with +1.5% inflation, for a total of +4%. That probably also translates into +8% growth in profits for S&P subsidiaries located there, and a +8% advance in eps.
Given that 25% of the profits of the S&P 500 come from the EU, this means that region’s contribution to index earnings will be +2%.
Let’s separate emerging markets into Greater China and everyone else. In broad strokes, the everyone else are natural resources producers, who are in recession and who will make a negative contribution to S&P 500 growth. The question is how negative the situation will be. -3%?
On the other hand, I think that mainland China and its direct sphere of economic influence will have a better 2016 than the consensus now expects. Let’s say +6%.
If we figure that China and the rest are both roughly equal in size, this implies that emerging markets, which account for 25% of the profits of the S&P, will make a positive contribution to growth in earnings, but a negligible one. Let’s say +0.5%.
My back of the envelope analysis suggests that the growth in S&P 500 profits will come in at +6% – +7%. next year. Not a banner result, but still enough to nudge the index ahead.
the price earnings multiple
In what will be a period of rising interest rates, it seems that there can be no cogent argument for PE multiple expansion in 2016. If anything, multiple contraction should be the order of the day.
On the other hand, the Fed’s intentions have been widely telegraphed for an extremely long time, so it’s equally hard to argue that the market hasn’t already factored into today’s prices a large portion of any negative effect. In fact, it seems to me that the market PE already incorporates in it all the tightening the Fed is likely to do. Nevertheless, there’s always someone who hasn’t gotten the memo, so there will be some negative effect, at least initially.
The most prudent assumption, I think, is that Fed tightening will make little difference to the PE. The contrarian in me says the money-making stance to take is that the PE will rise once the market sees that Fed tightening will only occur very slowly. But I’m not willing to take that risk.
a market of stocks
If I’m correct, 2016 will be a mildly positive year, where outperformance will come from astute stock selection rather than playing macro trends.
On Monday: adjusting for natural resources, especially oil.
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