Don't Write-Off Domestic Equities Just Yet
Cory Krebs is portfolio manager of the Catalyst Dynamic Alpha Fund (CPEAX).
U.S. equities have risen over 200 percent since their bear market lows nearly six years ago, leaving many investors looking for a signal to mark the culmination of this prolific ascension.
Despite any number of risk factors that could conspire to halt the progress of the current bull market, equities continue to present a compelling profile for positive returns in the near future.
Domestic equities, in particular, could very well propagate their gains in the year ahead.
Growing heights of a bull market tend to ignite predictions and anticipation for when the other shoe will drop. But simply because equities produce robust returns in a given calendar year does not mean there is a predisposition to sub-par results in the subsequent twelve month period.
In instances where the S&P 500 rose more than the current proxy, the index logged a positive advance in the subsequent calendar year two out of every three occurrences, with an average return of more than 10 percent in the third year.
So while it is undoubtedly true that, at some point, strong current performance begins to erode the potential of future gains, the current posture of the index does not appear unduly compromised.
It is true that the market faces some robust challenges.
Falling end demand and stubborn deflationary pressures persist in Europe and Asia. As a result, these countries have commenced large-scale asset purchase programs similar to QE in the United States, which the Federal Reserve, for its part, is now winding down. In October, Japan expanded its program to a staggering 80 trillion yen annually, and the ECB recently began a 1.1 trillion Euro program of its own.
The outcome of these measures is unclear. Intended to boost demand and asset values, they may elevate a number of risk factors, a rise in the U.S. dollar among them. Although falling oil prices, a consequence of decreasing demand, a supply glut, and a strong dollar, are a strong positive for the consumer in the long term, they could have negative market implications in the short term.
Fortunately, the U.S. is in a good position compared to the rest of the world.
Consumer confidence is rising, and for good reason. Robust employment trends, along with falling energy prices, have propelled consumer spending upwards, with retail sales rising in excess of 5 percent last year, as did industrial production. Both metrics have exceeded their pre-recession peaks.
Households have de-leveraged, and obligations as a percentage of disposable income have fallen to multi-decade lows. Meanwhile, corporate profitability and fiscal health are at all-time highs. Much like the consumer, business retrenched during the initial phase of the recovery, favoring stock buybacks, dividends and merger activity.
But, those trends have moderated recently, and fixed investment appears poised to re-accelerate, despite the slowing of investment from the energy sector. As business finally regains confidence, deployment of capital in long-term objectives could become a strong driver of domestic economic activity.
These trends have analysts anticipating a rise in corporate earnings of 14 percent this year. That should portend further stock market gains, even if valuations moderate. As the Federal Reserve nears the end of its program, the domestic economy is transitioning to Fed-independent durability. The U.S. can face the uncertain outcome of monetary programs in the rest of the world from a position of strength.
There is an old adage: "When the U.S. sneezes, the rest of the world catches a cold."
The current economic and market climate is ready to test the converse of this heuristic. The U.S. economy appears to be accelerating, but it is uncertain if domestic momentum will be sufficient to propel the rest of the globe forward, or if the U.S. will be halted by international weakness.
Continuing growth will likely mean the end of the Fed's zero interest rate policy and a rise in rates before the end of 2015. That rise shouldn't correlate directly to lower equity prices, but the complexion and magnitude of future gains would likely be altered. In this environment, we favor growth-styled equities over value-oriented stocks and large-cap companies to small-cap firms.
Large cap growth stocks trade at reasonable valuations relative to their historic averages and offer an opportunity to benefit from the improving cyclical sectors of the economy. With valuation slippage unlikely to significantly offset stock market appreciation, we believe domestic equities present a compelling case in 2015, especially when judged against the merits of other broad asset classes.
Cory S. Krebs; Portfolio Manager, Cookson Pierce Investment Management
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