Blink and you missed it. With stocks surging back to green and CNBC celebrating, one could be forgiven (were on a goldfish) for believing everything is truly awesome again. However, as Deutsche Bank details, there are ten good reasons why this is far from over...
As Deutsche's David Bianco explains, here are 10 reasons why the S&P likely dips 5-10% or possibly more before any sustained recovery...
1. Poor S&P 500 sales and EPS growth, even ex. Energy
Amid low commodity prices, the stronger dollar, weak investment spending, weak exports and slower foreign markets, S&P sales growth has been poor, even ex. Energy
2. Demanding valuations vs. history, especially ex. big Banks and Tech
3. Plunge in commodity prices has taken another significant down leg
4. Strong dollar with further upside likely even upon modest Fed hikes
5. Subpar US growth trends with weak productivity and investment
6. US and DM acceleration unlikely to offset slowdown in China and EM
7. Record high S&P margins, approaching record years of EPS growth
The GAAP/non-GAAP S&P EPS ratio deteriorated from 94% during 1Q13-3Q14 to 78% the past 3 quarters. Loss on asset sales, asset/ goodwill impairments and restructuring costs lowered the ratio significantly at Energy, Industrials & Materials. Higher M&A costs and excluded stock compensation dragged the ratio lower at Tech, Staples & Healthcare. Pension losses lowered the 4Q ratio too. The S&P avoided down EPS in 1H15, up ~2% y/y on non-GAAP EPS, but the GAAP EPS declined by 13% y/y. We have always argued that the best EPS measure lies somewhere between GAAP and non-GAAP EPS.
8. 3.5+ years since the last correction, no 5%+ dip yet in 2015
10% corrections happen about once every 2 years. Although it has been 978 trading days (as of August 20, 2015), i.e. 3.88 years since last correction, the last -19.4% correction on Oct 2011 was severe, and the Apr-Jun 2012 sell-off (9.94%) was just shy of 10%.
There were several multi-year periods without a 10%+ correction: Oct 57 – Jan 60, Jul 62 – Jan 66, Aug 84 – Jul 87, Nov 90 – Sep 97, and most recently Apr 03 – Sep 07.
9. Fed hikes loom on tightening job market despite slow GDP/ low CPI
10. No sign of baton pass to investor equity demand as buybacks plateau
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Ironically, as stocks rebound (on AAPL and hopes of a delayed rate hike) the reflexive bounce actually increases the chance of earlier rate hikes. As Bianco concludes, Sept Fed hike still likely if S&P > 2000, but perhaps one and done for 2015
Our near-term expectation for a 5-10% dip is in part because we think the Fed hikes despite slow growth.
The Fed not hiking might reduce S&P downside risk this autumn, but we think it would equally limit upside potential until a hike occurs. We think the best scenario for the S&P over the next 6-12 month period is the Fed hiking sooner rather than later, while communicating a likely FF rate path of not exceeding 1% in 2016 and not above 2% in 2017.