Category Archives: Shaping a Portfolio for 2016

Shaping a Portfolio for 2016: summing things up

December 11, 2015 By in Shaping a Portfolio for 2016, Uncategorized Tags: , , , , 1 Comment

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.

the US

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

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%.

emerging markets

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%.

the total

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.

 

 

 

 

 

Shaping a Portfolio for 2016: petrodollars

December 10, 2015 By in oil and natural gas, shale oil, Shaping a Portfolio for 2016, Uncategorized Tags: , , , , , 1 Comment

Petrodollars is the term coined in the 1970s to describe the money flow from oil consuming nations to oil producers–meaning by and large OPEC–during a decade when the crude oil price skyrocketed from around $3 a barrel in 1970 to $25+ in 1979.

Some economists of the day feared that this massive increase in money paid for fuel would be, in effect, withdrawn from circulation in the global money supply, and that the resulting money supply contraction could cause a worldwide recession.  (I have no idea where this notion came from, but it was seriously discussed.  Another strange idea being floated then was of the “backward-bending demand curve,” i.e., that there was something magical about oil so that the higher the price went, the more demand increased.)

What happened instead was that these funds were quickly recycled into the world money supply through increased spending by OPEC and through gigantic purchases of financial and other assets, from Treasury bonds to real estate to large stakes in publicly listed companies in Europe and the US.

Economic growth in the OECD did slow markedly during the 1970s and inflation rose sharply in places like the US, as industry heavily reliant on ultra-cheap oil struggled to adjust.  One might also argue that the fact that money was going from the pockets of avid consumers to those of wealthy savers also retarded economic expansion.

What I’ve just written is only interesting, other than to me, because the reverse of that 1970s flow is now happening.  More money is remaining in the hands of consumers.  According to the Financial Times, during the September quarter alone, Middle Eastern sovereign wealth funds cashed in at least $19 billion of their investments to underpin current government spending. Since not all asset manager report withdrawals, the true figure could easily be twice that.

It’s clear that a large shift of wealth away from OPEC and to oil consumers is under way.  But, in addition, as OPEC liquidates financial investments to fund current spending–Saudi Arabia is actually talking about issuing international bonds to fund its budget deficit–it will provide another monetary (and consumption) tailwind for economic growth in 2016.

Shaping a Portfolio for 2016: currency and interest rates

December 9, 2015 By in currency effects, Shaping a Portfolio for 2016, Uncategorized Tags: , , , 1 Comment

currency

Japan and the EU have tried over the past several years to jumpstart their economies through massive currency  depreciation.  This has resulted in a gigantic loss of national wealth in both regions.  It has also depressed the local standard of living by making dollar-denominated commodities–energy, food, metals, textiles–more expensive.

But the move has also revived industry, at least in the EU, by making end products cheaper.

Therefore, Europe could see substantial export-based growth in 2016.  As usual, I’m thinking that Japan is a lost cause.

interest rates

The US is alone among major countries of the world to have recovered far enough from the 2008-09 recession to begin to raise interest rates from their current intensive care lows.

The Fed Funds rate will most likely be be boosted to +0.25% next week.  And the benchmark will doubtless be raised again in 2016.  Nevertheless, the initial increases will probably have little, if any, negative effect on economic activity.

My guess is that we’ll exit 2016 with the Fed Funds rate at 1%.

At first blush, it would seem that by increasing interest rate differentials between the US and the rest of the world, the Fed would induce international fixed income investors to reposition their portfolios. Selling foreign bonds and buying US Treasuries would give them both higher interest income and the chance at a currency gain–since the flow of foreign funds into the US would imply further strength in the US$.

However, the Fed move has been widely telegraphed for an extended period of time.  We’ve already seen considerable struength in the US$ in 2015.  My guess is that most of the potential asset shift has already taken place in 2015.

So, I’m thinking that the Fed’s interest rate moves will be a non-event in both domestic economic and currency terms.

Tomorrow:  petrodollars

Shaping a Portfolio for 2016: emerging markets

December 8, 2015 By in economic problems in emerging countries, emerging markets, Shaping a Portfolio for 2016, Uncategorized Tags: , 1 Comment

your father’s emerging markets…

I started working in emerging markets in 1984.  At that time, the most important were Hong Kong and Singapore.  If one were feeling adventurous, Thailand, Malaysia and even Indonesia (shudder!) beckoned.  Taiwan and Korea were also on the list, but not easily accessible to foreigners.

At that time, there was a certain equivocation in the “emerging markets” term.  Yes, the stock markets were relatively rudimentary and overlooked by investors in the US and the EU.  But the economies of the big ones, Hong Kong, Singapore, Taiwan and Korea, were all advanced, with living standards for the average resident somewhere between those in Europe and the US.

With the notable exception of Indonesia, the 1980s-style emerging markets were all oil importers (Malaysia and Thailand have large reserves of natural gas, and export LNG, but that’s a different thing).

Back in the day, investing in Hong Kong was all about the then-colony, now SAR, with exposure to the mainland limited to the successors to the nineteenth-century opium traders and a few small manufacturers with operations on the mainland.

Mexico was the notable emerging market not in the Pacific.

 

…and today’s

China is now, of course, the emerging markets behemoth.  Direct access to foreign portfolio investors isn’t seamless.  Nor, in my view, is it desirable.  However, the investment significance of Hong Kong has radically shifted, from a focus on the physical place to the access its China-related listings allows to the mainland.

Perhaps more important for today’s economic situation, however, the emerging markets arena has expanded to include much more of Latin America (think: Brazil or Venezuela)–and, after the fall of the Berlin Wall, Russia and Eastern Europe as well.  Some thrill-seeking investors have tiptoed into the Middle East as well.

Two strong net effects:

–the emerging markets category contains many more emerging economies, with less stable politics, and

–today’s emerging markets are heavily weighted toward exporters of natural resources, especially oil.

for 2016:

China is several years into a transition from being an export-oriented manufacturer to being a domestic demand-oriented service economy.  The way I look at it, China is doing better than the consensus thinks–and will continue to do so in 2016.

The rest of the emerging markets arena is a mess.  Economically, that’s mostly because so many countries depend on mineral exports.  From a stock market point of view, it’s that plus the high weighting of natural resource issues (including banks that finance them) in the local indices.

My guesstimate is that Greater China will show 6% real GDP growth in 2016.  As a group, the rest will be in the minus column.  I have no idea what the net result will be.  I’m planning on it being mildly positive.

Until the oil price begins to recover–mid-year at the earliest, I think–I don’t see this as a time to hold an emerging markets index.  Individual stocks or a China fund/ETF is the way to go.  Other than China, developed markets, rather than emerging markets, are the place to be.

 

 

 

 

 

 

 

 

Shaping a Portfolio for 2016: the EU

December 7, 2015 By in Shaping a Portfolio for 2016, Uncategorized Tags: , , , , Leave a comment

the secular situation isn’t great

On average, the population of the EU is older than that of the US and younger than Japan’s.  It faces the same problem as the two other traditional economic powers of waning trend GDP growth, based on minimal expansion of the workforce.  If the workforce in the US is growing by 1%+ per year and Japan’s shrinking by -0.5%, the EU’s is  somewhere in the middle, rising by, say, 0.5%-.

It, too, is caught by anti-change forces bolstered by claims of “exceptionalism,” but of a complex sort.  France, Italy, Germany, the UK…each claim that it is exceptional–and that the others are not.  This hinders productivity growth.

All in all, not a pretty sight for investors.

cyclically, though…

…the EU has several positive factors going for it at the moment:

–the value of the € against the dollar has fallen from $1.40 in mid-2014 to $1.08 now.  That’s almost a 25% drop.  Yes, the devaluation has caused a massive decrease in €-area wealth.  But that’s the past.  The currency decline is also acting as a significant boost to economic activity, in the same way a sharp drop in interest rates would.  This positive effect is most pronounced for export-oriented or import-competing activities.

–after several years of GDP-growth pummeling austerity measures, the EU has belatedly adopted the same quantitative easing the US successfully used to restore economic growth.  As a result, the EU is in a sense like the US with a three-year lag–meaning growth can have a monetary tailwind aiding it for the next few years.

–the EU gets most of its hydrocarbon energy from abroad.  Russia, for example, is a mammoth supplier of natural gas to the union–all priced on a heating value equivalent with oil (translation:  it’s very expensive).  As a result, the EU is a prime beneficiary of the drop in the oil price over the past year or so.  The decline in the € has offset that a bit, but oil still costs 40% less today in euros than in early 2014.

–the Grexit crisis is over.

–emigration from the Middle East, especially Syria, is a big plus.  An influx of millions of young, motivated, reasonably trained workers is precisely what a sclerotic EU workforce needs to underpin GDP growth.  Chauvinistic politicians will doubtless dampen the effect somewhat, but this is still a significant long-term positive.

 

All in all, I think the EU has the potential for surprisingly strong economic performance in 2016.