The average U.S. diversified stock mutual fund returned +7.21% for the full calendar year 2014. This category is represented by over 8,000 mutual funds of all shapes and sizes, according to Morningstar data, and represents over $5 trillion in assets. Still, we believe there is ample opportunity for stocks to post additional gains this year and here’s why:
1. Earnings. Earnings drive stock prices. Corporate earnings are projected to rise 10% in 2015. The average dividend yield is 2%, so stocks only need to rise 8% in price to generate a total return of 10%. If earnings grow as projected, we could see stocks return well over 10% without any expansion in the price to earnings (P/E) multiple.
2. Historical Average. The 100-year average total return for stocks is very close to 10%. This year should be better than average given where we are in the election and economic cycles. The third year of a President’s second term is normally good for stocks. Gridlock is good—as far as the market is concerned. The balance of power between the President and Congress means nothing bad can get done. Finally, the weak economic recovery is finally starting to show some signs of strength.
3. Inflation. Inflation is not only low, it’s virtually non-existent. In fact, several members of the Federal Reserve committee have expressed mild concerns about the risk of deflation, rather than inflation. This provides a very supportive environment for the market’s currently modest price to earnings ratio (P/E) of 17, which is not historically high.
4. Interest Rates. Low interest rates mean lower borrowing costs and higher profits for most companies and they translate into lower interest payments and more disposable income for the average consumer. The average U.S. consumer is in better shape financially than they have been in for a decade. They have less debt, more savings and more disposable income. Our federal, state and local governments all utilize a significant level of debt, and they are greatly benefited by low interest rates.
5. Job Growth. Unemployment is falling and as more jobs are created, more people are entering the workforce. This leads to investment and more job creation, which in turn drives higher consumer spending and corporate earnings. Wages are ticking up and job mobility is increasing, meaning more employees are willing to switch companies in order to advance their careers.
6. Federal Debt Level. With more people working, Federal unemployment costs are dropping, payroll taxes are rising as are corporate profits. This translates into lower costs and higher tax revenues for Uncle Sam. This has allowed the federal deficit to be cut by nearly 2/3’s compared to 4 years ago.
7. Confidence. With the government in better shape and with more people working, consumer confidence and consumer spending have both risen sharply. This has led to business expansion and job growth. Money that had been sitting on the sidelines is coming back into the stock market and the economy in the form of capital investment, hiring and spending. There is still a lot of cash sitting on the sidelines at the corporate level, which means increasing dividends, stock buybacks and acquisitions, all of which tend to justify higher stock prices.
8. Oil Prices. The fall of oil from $110 to $45 is starting to put real, spendable money in the pockets of most consumers. 90% of the companies in the S&P 500 index benefit from lower oil prices which means higher earnings.
9. Stock Prices. The market has been resilient. Even after a 7% selloff in October, it posted five 200+ point up days and bounced right back to near record highs by month end. The early January 2015 sell off, that included a stretch of 11 out of 14 down days, looks like it will regain much of that decline by the end of the month. It has not paid to be out of the market. Fewer and fewer investors are panicking out during market lulls. The predictions we made less than a year ago of Dow 18,000 have been realized. We also predicted Dow 20,000 within 3 years and we could end up hitting that level in 2015 if the current trajectory continues.
10. Safe Haven. We have one of the best performing economies in the developed world. Capital and talent are flocking to our borders as our system continues to be the most efficient, productive and consistent in the world. As a result, the U.S. dollar is hitting all time highs against almost every major currency. Our GDP (gross domestic product) is projected to expand by 3.3% in 2015. The U.S. is viewed as a relative “safe haven” while the rest of the world is still fragile. Greece continues to teeter. Europe & Japan are stalled. Russia, Brazil, Argentina, the Middle East and many other heavily oil-dependent countries around the globe are hurting from low oil prices. The U.S. could see additional inflows of global capital from investors pulling money from riskier markets.
11. Spending. Consumer spending is on the rise. October auto sales hit their highest level in 12 years. The housing market for existing homes is strong. Uncle Sam is greasing the skids for first time home buyers by lowering the cost of mortgage insurance. Long term interest rates recently dipped to near 40–year lows, thus a 30-year mortgage is now available for under 4%. Commodity prices are low which can spur invest-ments in plant and equipment. When lumber, concrete, copper wire and borrowing costs are cheap, why wouldn’t a company consider building another plant or warehouse?
12. Housing. And finally we come to the grand daddy of job creation and economic growth—new home starts. All the progress in the economy and the stock market over the past 5 years has been accomplished in spite of historically low new home starts. As discussed previously in this newsletter, new home starts are the life blood of most economic recoveries. They create a plethora of high-paying jobs and big ticket purchases such as furniture and appliances. One has to wonder how much better things will get once new home starts rise back to normal levels. Old inventory is pretty much worked off, real estate prices have been increasing, there is starting to be pent up demand and key construction costs (lumber, interest, and lot prices) are relatively low. New household formation in the U.S., both organic and from immigration, has remained steady, which means there will be a housing shortage at some point if new home starts don’t begin to rise back towards the mean. We think they will.
In summary, we expect good things for the markets in 2015. We don’t believe it adds value to try to time it. Clients need to resist the urge to overthink this market with arguments such as “the market is at a record high so it has to go down.” The fact is that it can keep going up and that it probably will. It doesn’t mean there wont be dips, but the market still has plenty of room to run. I’ve been investing in stocks and following the market for 35 years. This is what markets do. They spend a lot of time hitting record highs. Stocks generally go up 3 or 4 out of every five years. Keep in mind, we are still making up for the lost decade, 2000 – 2010, when there were 3 bear markets and the S&P 500 Index had a rare negative return over a 10-year period. After the lost decade, isn’t it understandable that we might be due to go up for a little longer than normal? Also, given that this has been one of the weakest and slowest recoveries in history, doesn’t it stand to reason that the recovery could drag on longer than average? Yes, the market will go down temporarily from time to time and eventually it will encounter another bear market, but it hasn’t paid to try to time this market or to be out of it for any length of time. We’ve been recommending staying the course and that has been and is still the best course of action.
Building Wealth Wisely requires talented, experienced people. At IMS, we continue to add to our deep bench. In 2014, we hired Dan Belica and Chris Magana. Dan brings over 30 years of investing experience to the table including a former seat on the Chicago Board of Trade, and most recently a very successful career at TD Ameritrade. Dan is well-versed in the stock, bond, futures and commodities markets but he really excels at delivering exceptional client service. Dan was hired to do business development, financial planning and manage client relationships, and we are happy to say that he has been doing quite well over the past year. Christopher L. Magana, MBA joined IMS in December after a year-long interview/courtship. Chris has a law degree and spent nearly 10 years at Westcoast Trust Company, a division of Columbia State Bank, doing research and portfolio management. Chris was hired because his proven value investment style is similar to what IMS has been practicing for the past 26 years. He was indeed a perfect fit and at 36, he joins Carl W. Marker, 52, as the co-portfolio manager of the IMS Dividend Growth strategy. Chris also performs stock research for the firm and manages separate accounts using individual stocks and mutual funds. Please welcome Dan and Chris to the firm and feel free to contact them with questions or drop by the office and introduce yourself.
We are blessed to have your continued loyalty and trust. Please know that we take pride in investing our own money right alongside our clients and shareholders and that we eat our own cooking. Let us know if there is anything we can do to serve you better. May the New Year find you happy, healthy, wealthy and wise.