U.S. Equities Hitting All-Time Highs. Now What? - US Bank · electronics and furniture sales have...
Transcript of U.S. Equities Hitting All-Time Highs. Now What? - US Bank · electronics and furniture sales have...
U.S. Equities Hitting All-Time Highs. Now What?Executive summary
U.S. equities have recently been at all-time highs, leaving many clients wondering what to do next. We’ve been receiving questions such as:
• Whatkeydrivershavebeenpushingequitypriceshigher?
• Whatimpactarecurrenteconomicindicatorshavingonequityreturns?
• Whatistheoutlookforyear-end2013andinto2014?
• Howmay2014possiblydifferfrom2013?
Inthispaper,weshareviewsaboutthecurrentequitymarketenvironmentandoutlineourperspectivesonwhatmaylieahead.
2013 performance
Theyear-to-dateperformanceofU.S.equitieshasbeensuperbandremarkablyresilient.Lookingback,it’simportanttorememberthatthisyearstartedwithconcernsaboutthefiscalcliff,sequestrationandtheimpactthatbudgetcutsandhigherpayrolltaxesmighthaveontheeconomy.Inaddition,therewerepreliminarydebtceilingdiscussionsandgeopoliticalissuessurroundingeventsinEgyptandSyria.Totopthingsoff,werecentlyexperiencedapartialgovernmentshutdown.Yet,throughitall,theS&P500isupover20percent(year-to-datethrough October30)andhastouchedall-timepricehighsduringOctober.Lookingdeeper, nineof10sectorsintheS&P500areupover10percentandfiveof10sectorsareupover25percent.So,bymostmeasures,performanceofU.S.equitieshasexceededexpectations.
Market and sector performance
The performance of U.S. equities has been extremely strong so far in 2013.
• We continue to believe that equities are reasonably valued and may be positioned to do well for the remainder of the year.
• The degree of upside potential for equities is likely to be more moderate in 2014.
• Our current portfolio guidance recommends a modest overweight position in equities.
Total ReturnPrice 2013
Index 10/30/13 Q1 Q2 Q3 YTD (10/30/13)
S&P 500 1763.31 10.0% 2.4% 4.1% 23.6%Dow Jones Industrials 15618.76 11.3% 2.3% 1.0% 19.2%Russell 2000 1105.50 12.0% 2.7% 8.5% 30.2%MSCI EAFE 1893.68 4.4% -2.1% 9.8% 18.1%MSCI Emerging Markets 1042.75 -1.9% -9.1% 4.8% -1.2%
Sectors of the S&P 500 Weight
Information Technology 17.8% 4.2% 1.2% 5.4% 17.4%Financials 16.7% 10.9% 6.8% 1.9% 26.5%Health Care 12.9% 15.2% 3.3% 5.9% 32.5%Consumer Discretionary 12.4% 11.8% 6.4% 6.7% 33.3%Energy 10.5% 9.6% -0.9% 4.0% 18.4%Consumer Staples 10.4% 13.8% -0.2% -0.6% 21.3%Industrials 10.3% 10.1% 2.2% 7.4% 28.1%Materials 3.3% 4.2% -2.4% 8.9% 16.3%Utilities 3.3% 11.8% -3.7% 0.5% 11.4%Telecommunication Services 2.6% 8.2% -0.1% -5.3% 9.8%
Source: FactSet
Important disclosures provided on page 5.
SITUATION ANALYSIS
Influences pushing equity prices higher
Thestrongequityperformancein2013,inourview,canlargelybeattributedtothreeimportantdrivers:FederalReserve(Fed)-drivenliquidity,price-earningsmultipleexpansionandeconomicimprovement.
• Fed-driven liquidity:Fed-drivenliquidityisafancywayofsayinglowinterestrates.TheFed’scurrentprogramtopurchase$85billionpermonthinTreasuriesandmortgage-backedsecurities,oftenreferredtoasquantitativeeasing(QE),isdesignedtodojustthat—keepinterestrateslow,particularlylong-datedmaturities,intheinterestofpromotingeconomicactivityandinflatingassetprices.Thishashelpedpushequities to higher levels.
Fed liquidity expansion helped lift stock market
2009 2010 2011 2012 Oct2013
S&P
500
pric
e le
vel
1,800
1,600
1,400
1,200
1,000
800
600
Federal Reserve – total assets ($ in m
illions)
$4,000
$3,500
$3,000
$2,500
$2,000
$1,500
Source: FactSet; data: October 25, 2013
• Price-earnings expansion: Equitieshavebenefitedfromprice-earningsmultipleexpansion,whichissimplyhowmuchinvestorspayfor$1ofcompanyearnings.Historically,duringtimesofsimilareconomicconditions(suchasinthe1960sandearly1970s)thatnumberhasrangedbetween15to18times.Atthestartof2013,theconsensuswasthatamultipleof14to15timeswasappropriate,butastheyearhasprogressedandthemarketworkedthroughoneheadlineafteranother,expectationsforahighermultiplealsoclimbedtoapointwhereamultipleinthe16to17timesrangewasconsideredbothappropriateandwarranted.
• Economic improvement: The U.S. economy has shownsignsofimprovementthroughouttheyear—inareassuchashousing,employment,retailsalesandmanufacturingconfidence—whichhashelpedmoveequitypriceshigher.Thelevelofimprovement,
however,remainsaworkinprogress.OfdebateiswhethertheeconomyisstrongenoughtooperateonitsownwithoutassistancebytheFed.
Key economic drivers
Amongkeyeconomicdriversimpactingequitypricesarehousing,employment,retailsalesandmanufacturing.The general conclusion is that these areas are all showing signsthateconomicimprovementisoccurring.
• Housing:Homesalesareupandhousingstartsremainbelowcapacity,buthomebuilderconfidence(asmonitoredbytheNationalAssociationofHomeBuildersIndex)indicatesweshouldexpectrisingactivityinthisarea.Theoutlookforhousingstillremainsfavorableasmortgageratesremainquitelowandhousingremainsaffordable.Additionally,the 50-yearannualizedrunrateofhousingstarts,accordingtotheCensusBureau,isapproximately 1.5millionunits,considerablyabovethecurrentlevelofroughly900,000.Thisleadsustobelievethathousingappearstostillhavelegsandremainsanimportantcomponentoftheeconomy.
Housing recovery underway—still room to grow
1964 1965-1969 1970-1974 1975-1979 1980-1984 1985-1989 1990-1994 1995-1999 2000-2004 2005-2009
Average
2010-Aug2013
# of
hou
sing
sta
rts(in
thou
sand
s)
2500
2000
1500
1000
500
Source: Bloomberg; data through 8/31/13
• Employment:Ingeneral,payrollgrowthhasbeenmodest,averaging185,000jobspermonthoverthepastyear.Adisappointingincreaseof148,000jobswasrevealedbythedelayedSeptemberjobsreport.However,theunemploymentratedeclinedto 7.2percentandtemporaryemploymentincreased,whichisoftenaleadingindicatorofpermanenthires.
Important disclosures provided on page 5. Page 2
SITUATION ANALYSIS | U.S. Equities Hitting All-Time Highs. Now What?
Unemployment rate is still high, but improving
Feb2009
Feb2010
Feb2011
Feb2012
Feb2013
Aug2009
Aug2010
Aug2011
Aug2012
Aug2013
Unem
ploy
men
t rat
e
10.5%
10.0%
9.5%
9.0%
8.5%
8.0%
7.5%
7.0%
6.5%
6.0%
5.5%
5.0%
4.5%
4.0%
Source: Haver Analytics
• Retail sales: Results have been mixed. Cars, electronicsandfurnituresaleshavebeenrelativelystrong in recent months. Conversely, clothing and departmentstoresaleshavelagged.Thispresentssomeuncertaintyregardingtheupcomingholidaysalesperiod.Weknowtherehasbeensomepent-updemandforautosinrecentmonthsandfavorablefurnituresalescanpartlybeattributedtothehousingmarket.However,apparelsaleshavegenerallylaggedasconsumershaverefrainedfromoverextendingthemselves. That said, it seems too early to have agoodreadonthelevelofholidaysales.Plus,consensusexpectationsaregenerallylow.Theoutlookforholidaysalesshouldbecomemorevisibleaftermorecompaniesreportthirdquarterresultsandoffersome year-end guidance.
• Manufacturing: Manufacturingcontinuestoimproveandgainmomentum.TheInstituteofSupplyManagement(ISM)ManufacturingIndex,agaugeonmanufacturingconditions,isatatwo-yearhighlevel.Increasingdemand,bothathomeandabroad,pluslowinputcosts(suchasenergy)arehelpingdriveearningsandsharepricesofmanyindustrial-relatedcompanies.
Looking ahead
Inourview,U.S.equitiesseemlikelytotrendgenerallysidewayswithanupwardbiastowardyear-end.Aswelookfurtherinto2014,weseeU.S.equitiesmovingstillhigher,albeitatamoremoderatepacethanwhatisbeingexperiencedin2013.
• Monetary policy risk:FederalReservemonetarypolicy,includingthetimingoftaperingtheQEbondpurchasesremainsarisktoequitymarkets.FollowingtheSeptemberjobsreport,theconsensusisnowfortheFedtoannouncetaperingofQEafterthefirstof
theyearandperhapsnotuntiltheMarchFederalOpenMarketCommitteemeeting.ThismayexplainsomeofthestrengthofequitiesexperiencedinrecentdaysastherunwayforFed-drivenliquiditymaybeextendedforafewmonthslonger.Nonetheless,itisstillonlyamatteroftimebeforetheunconventionalFedmonetarystimulusends.WesuspectU.S.equitiesmayinitiallytrend downward on the news as we will be in uncharted territory.Ataminimum,taperingrepresentsachangeintrend and with change comes uncertainty, anxiety and volatility.However,wealsobelievethatanydowndraftassociatedwiththetaperingislikelytobeshort-lived.
• Data integrity:Manyreadingsorindicatorsofeconomic health were held hostage by the Washington budgetanddebtceilingimpasse.Assuch,dataqualityislikelytobequestionedforthenextcoupleofmonths because it was either not collected during the shutdownorthevalidityissuspectduetoshutdown-relatedimpacts.Wesuspectitwilltakeamonthortwoforeconomicreleasestogetagoodreadonthehealthoftheeconomy.
• Contained inflation: We believe the current environmentofbenigninflationriskprovidesafavorablebackdropforequityprices.Lookingbackatperiodsofhighinflation,suchasduringthelate1970sandearly1980swheninflationbegantoramp,interestratesincreasedandthe10-yearTreasuryyieldrosetoover14percentin1981.Duringthatperiod,price-earningsratiosfelltotheseventoeighttimesrangeatthelowpoint.Incontrast,todayinflationisbenign—infact,thereisanequalconcernofdeflation.Inthisscenario,webelieveprice-earningsratiosarelikelytostaynearcurrentlevels,witharguablystillsomeupsideroomformodestexpansion.
Inflation: None in sight
Actual Projected
2000 2004 2008
Perc
ent c
hang
e
2012 2016 2020 2024
4%
3%
2%
1%
0%
Overall
Core
Source: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor; Bureau of Labor Statistics; Federal Reserve
Important disclosures provided on page 5. Page 3
SITUATION ANALYSIS | U.S. Equities Hitting All-Time Highs. Now What?
Comparing and contrasting 2013 and 2014
Lookingbeyondthenextthreetofourmonths,andassumingwegetthroughthenextroundofbudgetanddebtceilingdiscussionsinJanuaryandFebruary,aswellasthefirstroundofFedtaperingwithoutanymajordisruptions,2014islikelytodifferfrom2013inseveralways.
• Transition year: Inourview,2014islikelybeatransitionyearfortheequitymarketsduetothepotentialforchangeinFedpolicy,limitedearningsmultipleexpansionandatransitiontorevenueexpansionfromprofitmarginexpansionforcompanies.WeanticipateanendtothecurrentQEprogramin2014,althoughtheFedisunlikelytoraiseshort-terminterestrates,whichshouldtemperequitymarketgrowth.Price-earningsmultipleexpansionhasbeenaprimarydriverofequityincreasessofarin2013.Withmarketmultiplesaroundthehistoricaverage,webelievethemarketwillbeunlikelytoawardsimilarprice-earningsmultiplegrowthin2014asitdidin2013.Arguably,Fedtaperinglikelyindicatesaself-sustainingeconomicexpansion,whichshouldleadtoimprovingrevenuegrowthforcompanies,potentiallyprovidinganewpathforequitymarketappreciation.
• International boost: While there remains much uncertaintywithinternationalmarkets,wearecautiouslyoptimistic.Performancehasvariedyear-to-datewithinternationaldevelopedandemergingmarketslagginginthefirsthalfof2013.However,morerecently,developedinternationalhasrallied.SeveralU.S.multinationalcompaniesthathaveaninternationalfootprintarealsoreportingthatconditionsinEuropeareshowingmodestsignsofgrowth,whileemergingmarketsappeartobegenerallystabilizing.Ifthesetrends continue, this seemingly suggests that U.S. multinationalcompaniescouldgetaboosttoearningsin2014,atleasttoagreaterextentthanhasbeenthecasein2013.
Conclusion
TheperformanceofU.S.equitieshasbeenremarkablyresilientsofarin2013.Infact,ithasbeena“buyonthedips”equitymarketthroughouttheyearasthebroadequitymarkethasforgedthroughoneheadwindafteranother.Aswelooktowardyear-endand2014,webelievetherearereasonsforcontinuedoptimism.Manyofthedriversthatareresponsibleforpushingequitypriceshigherremaininplace—interestratesarelow,valuationisfair,inflationisbenignandsentimentisgenerallypositive.Inourview,thesedriverspresentafavorablebackdropforequitiesandarereasonsthatleadustobelieveU.S.equitieswilltrendstillhigherinto2014.Thatsaid,thedegreeofupsideislikelytobemoremoderatein2014thanthisyearasearningsaccelerationisarguablyrequiredtopushequitiestomeaningfullyhigherlevels.Forthattohappen,weneedtoseemorewidespreadevidenceofeconomicimprovementandanticipatethatglimpsesofprogresswillbeseenbythefirstquarterofnextyear.Ouryear-end2013pricetargetfortheS&P500is1760.However,weseeupsidepotentialtothe1815range,whichisroughly3percentabovecurrentlevels. Atthistime,our2014pricetargetis1900,approximately8percentabovecurrentlevels.
Important disclosures provided on page 5. Page 4
SITUATION ANALYSIS | U.S. Equities Hitting All-Time Highs. Now What?
Investments are:
NoT a DePoSIT NoT FDIC INSUReD MaY LoSe VaLUe NoT BaNk GUaRaNTeeD NoT INSUReD BY aNY FeDeRaL GoVeRNMeNT aGeNCY
This commentary was prepared on October 30, 2013 and the views are subject to change at any time based on market or other conditions. This information represents the opinion of U.S. Bank and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not responsible for and does not guarantee the products, services or performance of third party providers. Any organizations mentioned in this commentary are not affiliates or associated with U.S. Bank in any way.
Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the stock market in general. The Dow Jones Industrial Average (DJIA) is the price-weighted average of 30 actively traded blue chip stocks. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, and is representative of the U.S. small capitalization securities market. The MSCI EAFE Index includes approximately 1,000 companies representing the stock markets of 21 counties in Europe, Australasia and the Far East. The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.
© 2013 U.S. Bancorp (10/13)
reserve.usbank.com
Contributed by: Terry D. Sandven Chief Equity Strategist
SITUATION ANALYSIS | U.S. Equities Hitting All-Time Highs. Now What?
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