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Weekly Market Commentary 03092015

by Burt White Chief Investment Officer, LPL Financial, and Jeff Buchbinder, CFA Market Strategist, LPL Financial

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302 views

Weekly Market Commentary 03092015

by Burt White Chief Investment Officer, LPL Financial, and Jeff Buchbinder, CFA Market Strategist, LPL Financial

Uploaded by

dpbasic
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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LPL RESEARCH

WEEK LY
MARKET
COMMENTARY

KEY TAKEAWAYS
The current bull market
celebrates its sixth
birthday today
(March 9, 2015).
Bull markets do not
die of old age, they
die of excesses, and
we do not see
evidence of excesses
emerging today.
Some of our favorite
leading indicators
suggest the economic
expansion and bull
market may continue
through the end
of 2015.

March 9 2015

HAPPY BIRTHDAY BULL MARKET


Burt White Chief Investment Officer, LPL Financial
Jeff Buchbinder, CFA Market Strategist, LPL Financial

The current bull market, one of the most powerful in the S&P 500s history,
celebrates its sixth birthday today, March 9, 2015. The S&P 500 has more than
tripled since the financial crisis closing low on March 9, 2009 (the index is up 206%
since then), achieving a cumulative return, including dividends, of 244% (22.8%
annualized). Since World War II, just three other bull markets have reached their
sixth birthday, and only one (19821987) produced bigger gains ahead of its sixth
birthday, as shown in Figure 1.

We define a bull market as a prolonged period of


S&P 500 gains without a 20% or more decline.

IS THIS BULL SET TO END?


We do not think this bull market is about to end just because its six years old. Bull
markets do not die of old age, they die of excesses, and we do not see evidence
today that economic excesses are emerging. There is still slack in labor markets
despite healthy job growth in recent months. The credit markets reflect rational
behavior. We see few signs of overbuilding in the commercial and residential real

ONE OF THE STRONGEST BULL MARKETS SINCE W WII

03/09/2009

12/04/1987

05/27/1970

10/22/1957

10/09/2002

08/11/1982
10/03/1974

10/07/1966
06/27/1962

06/13/1949

10/11/1990
250%

200%

150%

100%

50%

0%

Source: LPL Research, FactSet 03/06/15


Past performance is not indicative of future results.
Indexes cannot be invested into directly.
01

Member FINRA/SIPC

WMC

estate markets. Inflation (with or without the effects


of depressed energy prices) remains low, which
has enabled the Federal Reserve (Fed) to remain
accommodative. The accommodative Fed provides
further evidence of the absence of the types of
excesses that have marked prior stock market peaks.
Historically, the timing of Fed rate hikes can provide
some insight into when recessions might be coming
(though the Feds track record is far from perfect).
The Fed typically reacts to built-up excesses with
multiple rate hikes, contributing to the start of
recessions. Bear markets then begin as market
participants anticipate those economic downturns.
Most of the post-WWII bull markets, including the
internet and housing bubbles in 2000 and 2007, came
after a period of multiple Fed interest rate hikes. The
slow economic recovery has delayed the formation
of excesses and the start of the Feds rate hike
campaign. Rate hikes will comeperhaps as early as
this summerbut until we see more evidence that
economic growth and monetary stimulus from the

Fed are creating worrisome inflation, we expect this


bull market will live on.
Looking for a Warning Signal
To help us possibly get some warning on when
a market downturn may be coming, we have
identified several leading indicators (which we have
dubbed the Five Forecasters, as discussed in our
Outlook 2015: In Transit publication) that have been
pretty effective predictors of impending market
downturns and recessions when combined. These
indicators give us more confidence in our positive
stock market outlook for 2015 [Figure 2].

WHAT ABOUT VALUATIONS?


The one Five Forecaster that has sent off a
potential warning signal is valuations. The trailing
price-to-earnings ratio (PE), the series that goes
back the furthest, stands at 17.5 (as of March 6,

FIVE FORECASTERS SUGGEST LOW PROBABILITY OF RECESSION OR BEAR MARKET IN THE COMING YEAR
Late-Cycle Warning?
Forecaster

The Signal

Treasury Yield Curve

An inverted yield curve, defined as a 3-month Treasury yield


more than 0.5% higher than the 10-year Treasury yield.

Leading Economic Indicators

The year-over-year change in the Conference Boards


Leading Economic Index (LEI) turns negative.

Market Breadth

A decline in a measure of the number of stocks advancing


compared to the number declining over time when the price
level of the NYSE Composite Index is still making new highs.

Purchasing Managers Index

There is no clear signal, but an unambiguous peak in the ISM


Purchasing Managers Index (PMI) can be considered a
potential warning.

Market Valuation
Price-to-Earnings Ratio (PE)

The PE for the S&P 500 (the S&P 500 Index price divided by
1-year trailing operating EPS) is above 17; however, it can
stay elevated for a long period of time.

Source: LPL Research 03/06/15

02

Member FINRA/SIPC

No

On Watch

Yes

WMC

2015, based on Thomson Reuters earnings data).


That is above the long-term average dating back
to World War II of 15.1, but not much above the
average since 1980 of 16.4 [Figure 3].
While valuations may be higher, we do not think
it means an impending end to this bull market for
several reasons:
Valuations are not a reliable short-term
predictor. Although above-average valuations
may signal muted longer term returns, valuations
have proven to be a poor predictor of shorter-term
stock market performance. Prior bull markets have
shown that earnings gains can lift stocks for quite
a while even after valuations exceed long-term
averages and PE expansion is halted.
Stocks may be preferable to bonds. Low interest
rates have made bonds a less attractive alternative
to stocks, making stock valuations more attractive.
Stocks may be slightly overvalued, but bonds are
much more stretched, in our view.
Earnings gains are possibly set to continue. We
see continued, though modest, earnings gains
in 2015, as the benefits of lower energy prices

for consumers and businesses help offset the


sharp downturn in energy sector profits. Despite
sharp downward revisions to energy estimates,
consensus still reflects S&P 500 earnings gains
in 2015. The Institute for Supply Management
(ISM) Manufacturing Index, our favorite leading
earnings indicator, is still signaling positive
earnings growth despite dipping in recent
months. Corporate earnings are benefiting from
share buybacks (which lower share counts,
the denominator in the earnings per share
calculation), as well as low borrowing costs and
limited wage pressures, which are all helping to
support profit margins and continued
earnings growth.
Low inflation increases the value of future
corporate earnings, supporting stock
valuations. Though certainly tied to interest
rates and the Fed, and a driver of bond
performance, inflation by itself is a drag on
the value of cash flows and dividends that
corporations generate; therefore, it is a key driver
of stock market valuations.

VALUATIONS ARE ONLY SLIGHTLY ABOVE POST-1980 AVERAGE AND NOT EXCESSIVE IN OUR VIEW
S&P 500 Trailing Price-to-Earnings Ratio
35
30
25
20

Post-WWII
Average

15.1

Post-1980
Average

03/06/2015

17.3

16.4

15
10
5
0
48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 88 90 92 94 96 98 00 02 04 06 08 10

Source: LPL Research, Thomson Reuters, FactSet 03/06/15


Past performance is not indicative of future results.
Indexes are unmanaged and cannot be invested into directly.

03

Member FINRA/SIPC

12

14

WMC

CORRECTIONS CAN BE RARE IN LONG BULL MARKETS


Periods Without Double-Digit Declines
in the S&P 500

Number
of Days

October 11, 1990 October 7, 1997

2553

March 11, 2003 October 9, 2007

1673

October 3, 2011 March 6, 2015 (Present)

1250

July 24, 1984 August 25, 1987

1127

Source: LPL Research 03/06/15


Past performance is not indicative of future results.
Indexes are unmanaged and cannot be invested into directly.

ARE WE DUE FOR A CORRECTION?


After Are stocks too expensive? perhaps the
second most common question we have been
getting during the latest leg up of this bull market
is, Are we due for a correction? We define a
correction as a drop in the S&P 500 of 1020% (a
20% or more decline is a bear market). It has been
a long time since the S&P 500 dropped 10% or
more1,250 days to be exactbut we only have
to go back to the past two decades to find longer
periods. During the 1990s bull market, the S&P
500 went 2,553 days, or just shy of seven years,
without a correction, and during the 2000s bull
market, the S&P 500 went 1,673 days, or about 4.5
years, without dropping more than 10% at any point
[Figure 4]. The age of this bull market could mean
volatility may increase in the coming year, and 10%
corrections are fairly common, even in bull markets;
but the length of this period of relative calm is not
without precedent, so we would caution against
moving to a defensive stance in anticipation of
a correction.

CONCLUSION
Bull markets die of excesses, not old age. We do
not see the types of excesses in the U.S. economy
today that suggest a bear market decline is
forthcoming. The Fed, which has historically raised
interest rates multiple times before bull markets
end, has not yet begun to hike interest rates
during this cycle. And some of our favorite leading
indicators suggest the economic expansion and
bull market may continue through 2015. Although
valuations are above average and a correction may
come should the aging bull market become more
volatile, we think the chances are good that at this
time next year, we will be wishing this bull market a
happy seventh birthday. n

04

Member FINRA/SIPC

WMC

IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To
determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no
guarantee of future results.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a
falling market.
All investing involves risk including loss of principal.
INDEX DESCRIPTIONS
The Standard & Poors 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through
changes in the aggregate market value of 500 stocks representing all major industries.
The Institute for Supply Management (ISM) Index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM
Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors
conditions in national manufacturing based on the data from these surveys.
The Leading Economic Index is a monthly publication from the Conference Board that attempts to predict future movements in the economy based on a composite
of 10 economic indicators whose changes tend to precede changes in the overall economy.
The Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI is based on five major indicators: new orders,
inventory levels, production, supplier deliveries, and the employment environment.
The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a
financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to
one with lower PE ratio.
The trailing PE is the sum of a companys price-to-earnings, calculated by taking the current stock price and dividing it by the trailing earnings per share for the
past 12 months. This measure differs from forward PE, which uses earnings estimates for the next four quarters.
Earnings per share (EPS) is the portion of a companys profit allocated to each outstanding share of common stock. EPS serves as an indicator of a companys
profitability. EPS is generally considered to be the single most important variable in determining a shares price. It is also a major component used to calculate the
price-to-earnings valuation ratio.

This research material has been prepared by LPL Financial.


To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and
makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

RES 5009 0315 | Tracking #1-361611 (Exp. 03/16)

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