Looking at the strategists S&P 500 target levels, a better but not an especially good year is generally anticipated for US equities. With a mean value of 2245 index upside would be around 7% and, with yield and buybacks, this would produce a 10% total return. Such a capital gain appears somewhat optimistic, however, and would likely require higher than expected earnings growth to be achieved. Even then, there are numerous signs, other than generally high valuation metrics, that US equities may struggle again this year.
The UK faces a number of domestic challenges; economic slowdown, rising wage pressures and “Brexit” to navigate
Late cycle characteristics are becoming increasingly obvious, economic forecasts have eased back to a 2-2.5% range from 3% or year ago, the Fed is about to start a tightening cycle, credit spreads have widened, bond yields are expected to rise, profit margins are contracting and buybacks will become less attractive.
Within the market, financials tend to outperform as rates begin to rise while defensives do the reverse, the two-speed economy supports a consumer orientation relative to industrials while strong earnings growth should support IT despite high international sales. Mid and small cap valuations are similarly extended to large caps.
Does Europe Still Look a Better Bet?
2015 was a better year but, for non-eurozone investors, much of the main European indices gains were offset by euro weakness. Even so, the EuroStoxx index was up 14% at end November having overcome a range of negative shocks during the year. Europe ex UK remains a favoured market given it is still early in the recovery cycle and the European Central Bank is committed to policies to generate higher inflation that will by default be growth supportive.
Despite recent concerns over global growth and the Volkswagen emissions scandal, business sentiment has remained buoyant while credit growth continues to pick up. European earnings should accelerate over the next few years, possibly by 15-20% given the potential for margin expansion as they are some 30% below the previous peak.
While P/E valuations are not overly cheap in absolute terms the equity risk premium is high and equities appear attractive relative to other asset classes, especially with a 3% dividend yield. The German DAX is the market favoured by most strategists along with Italy.
After Two Flat Years Will the UK Rally in 2016?
Even the modest upside gains predicted failed to be delivered as once again the structure of the main indices and the earnings collapses recorded by a number of key sectors, namely oil and gas losing 46% and mining down 42% held back the indices. Additionally, earnings per share fell elsewhere, it being a fairly dire year for food retailers down 35%, mobile telecoms down 29% and pharmaceuticals down 8%, all of which contributed to a 3% year to date capital fall for the FTSE 100.
Even so, there were plenty of opportunities for active investors to make money in UK equities during 2015. As noted earlier most stocks performed significantly better than the main indices, one just had to avoid the big losing “value” stocks. The 50th percentile stock in the FTSE 350 excluding investment trusts, for example, has returned 11% year to date compared to a 2% index gain.
Analysts expect 2016 to produce higher aggregate earnings but there is a real possibility that both of the resources sectors record another year of losses and, even ex these sectors, just 5% earnings per share growth is forecast.
Potentially, 2016 could be a far better year for the UK should commodities rally. On the other hand earnings forecasts and hence dividend projections may still be too high should commodity prices remain under pressure. The UK also has a number of domestic challenges, namely some signs of economic slowdown, rising wage pressures and the small matter of “Brexit” to navigate.
Additionally, the strong performance of many individual stocks has ensured the UK market ex resources is not particularly cheap, the FTSE100 excluding financials, oils and mining currently sells on a 17.1x P/E for 2016 and the FTSE 250 16.3x, a near 20% premium to its historic average. This suggests another year for backing earnings growth with stock picking to the fore. Missing the turn in resources, however, could prove equally painful.
Is There Another Year of Japanese Gains To Come?
At least the Japanese stock market broadly delivered in 2015 with a 12% return. The index has doubled over three years and even recorded a 44% rise in sterling terms – the FTSE All Share +8% over the same time period.
Although most commentators are still forecasting relatively decent returns, enthusiasm for Japanese stocks is beginning to pall. Essentially, the same story has run for some time but the three main pillars of decent near term profits growth, relatively attractive valuations and corporate governance reforms remain, although the last is waning somewhat.
Of more concern is a less dovish Bank of Japan, the government’s popularity is declining and the likely success of “Abenomics 2.0” going forward is increasingly being questioned.
Even so, near term impetus should come from stronger economic growth, fiscal support and details of corporate tax changes which should contribute to further upward earnings revisions. Additionally, further domestic buying support is likely while foreigners were sizeable sellers during the near 20% August/September equity rout and are now underweight the market.
The index is still 7% below the August high and news flow should gradually improve. With his popularity on the slide Prime Minister Abe will wish to see a stronger economy ahead of important Upper House elections next summer.
Valuations remain a key support being on a number of measures, the cheapest global market. Overall, there is still a positive story but one not quite as compelling as previously. Nonetheless, it remains one of the preferred markets.
