At the start of the New Year we warned 2015 would bring greater market volatility. The first quarter did not disappoint as the stock market continued the pattern of setting new highs, correcting, and then setting higher highs. The month by month results show the see-saw pattern in the U.S. market and the surprisingly more consistent performance of international stock markets.

Our final four market moving news stories in the first quarter were: oil prices, the strength of the U.S. dollar, corporate earnings and the European Central Bank monetary easing program. The decline in oil prices has been a two edged sword. It has been a stimulant for the consumer; but painful for an energy industry moving from expansion to contraction. A twelve year high in the dollar versus the Euro has positive ramifications; but it has become a drag for U.S. companies exporting their products. Fourth quarter corporate earnings released in the first quarter has not been spectacular, although a majority of companies reported results better than expected. Winners like Apple were rewarded and the losers like Caterpillar were punished. Caterpillar was derailed by a combination of a weak demand, a strong dollar and disappointing earnings. In the first quarter the European Central Bank embarked on a U.S. style quantitative easing program. Six years after the original U.S. quantitative easing, it will be interesting to watch the European sequel.

This year’s first quarter results are very similar to a year ago, yet so is the macroeconomic environment. Interest rates are low by historical standards, the Fed monetary policy remains the same, the U.S. economy shows modest positive growth, the international markets are challenged, and geopolitical events continue to grab the headlines. From a valuation standpoint, forward price earnings ratios in the past year have expanded from 15 times to 17 times forward earnings. From here, price appreciation becomes more difficult. This market will require stronger earnings growth in the upcoming quarters to reach sustainable new highs. This is unlikely as earnings are being pressured by the strong dollar and lackluster economic growth. Low single digits returns from stocks this year would be a victory and mark the first time the U.S. stock market generated seven consecutive years of positive returns.

The bond market has entered a new era of extended low interest rates. Low interest rates will be the norm well into the foreseeable future. Demographics have created an insatiable appetite for fixed income investments as baby boomers try to protect principal and generate income for their living expenses. The bond market needs to come to grips with a Federal Reserve wanting to raise short-term interest rates in a weak economic environment. We expect marginally higher short-term rates later this year with stable longer term interest rates. Expect two to four percent returns from the bond market this year.

The remainder of the year will bring challenges and opportunities. The biggest challenge will come from within as investors need to manage their emotions in a volatile market. Commitment to your financial plan while keeping market driven emotions removed from the financial decision making process will be key. The long-term investor will be rewarded. Find your own distinct portfolio balance, embrace your financial plan and stay invested for the long haul.

MARKET BY NUMBERS:

The 1st quarter of 2015 is almost behind us and investment markets are relatively flat. This lines up with Nevada Retirement Planners and Gradient Investments forecast of a flat US market for the whole of 2015. One quarter into the year we don’t see any reason to change the forecast, but I do think it’s worthwhile to review why we see a flat stock market this year. In the next few paragraphs let’s highlight our rationale behind this forecast.

First, S&P 500 earnings estimates have gradually been revised lower this quarter. In fact, S&P 500 earnings growth is now forecast to decline by 4% and sales growth is expected to decline 2% in Q1 of 2015. This could be the first earnings decline since Q3 of 2012. See the chart below of consensus expectations for 1Q 2015 S&P 500 earnings growth.

Large earning declines in the energy sector are the main culprit behind this earnings decline, but the strong dollar is also crimping profits in multinational corporations that sell their goods and services overseas. Bottom line, it’s difficult to get the market moving when earnings aren’t doing well.

Secondly, the S&P 500 isn’t that cheap anymore. Valuation is currently at a ten year high. Below is a chart that illustrates the “forward price to earnings (PE) ratio” of the S&P 500. The blue line is the forward PE multiple.

The markets current valuation multiple is well above the 5 (green line) and 10 (gray line) year averages. It’s hard to get the market moving when stocks in general are fair to richly valued.

Finally, the economy is still growing, but recently not at the pace economists are predicting. The “Citigroup Economic Surprise Index” is an indicator that measures the amount actual economic data points are exceeding or disappointing economist predictions. In the chart below when the blue line is below zero “actual” economic data is disappointing the predictions of economists.

Recent economic reports like auto sales, durable goods and retail sales have been disappointing. The economy is still growing, just not as fast as many of the experts on Wall Street were expecting. Maybe it’s the recent bad weather, or maybe things are slowing a bit, we’ll see. Regardless stocks perform better when the economy is strong and exceeding expectations (which is not the case right now).

The combination of:
Decelerating corporate earnings growth
Higher market valuations and
Slowing economic data
keeps us comfortable with our current forecast for a flat 2015. Don’t panic, a flat year is OK. Over time stocks provide great long term returns, they just don’t go up every single year. In flat to down years dividends (G50 Portfolio) and yields (Absolute Yield Portfolio) go a long way to assisting performance returns.

We certainly don’t see a big correction in stocks, just not a lot of upside at this time. And we still continue to think stocks will outperform bonds over the next 3-5 years, so please don’t interpret this as a broad based negative call. For the time being let’s be prudent in our allocations, be globally tactical (GTR), keep some dry powder and prepare to allocate more offensively if we get a minor correction in the market.

As of March 30th, 2015:

Dow Jones US Moderately Conservative Index is up 2.50% (TR) for the year

S&P 500 closed at 2,086.24 up 1.85% for the year

U.S. 10 year Treasury Futures are yielding 1.96% down 0.21% for the year

WTI Crude Oil futures closed at $48.71 down $5.00 for the year

Gold closed at $1,183 per ounce flat for the year

To expand on these market reflections or discuss other portfolio strategies please don’t hesitate to reach out to us.