CUNA Mutual: Equity Market Update & Outlook

on 11:00 AM

By Robert F. DeLucia, CFA 
Consulting Economist for MEMBERS Capital Advisors, Inc.

Summary and Major Conclusions:

  • Despite significant day-to-day volatility, the US equity market has exhibited considerable stability over the past six months. The S&P 500 Index has traded within a historically narrow range since the end of last year, while popular measures of volatility have remained well below historical averages.
  • There is growing evidence of a massive valuation disparity between predictable growth versus cyclical stocks, a manifestation of an extreme investor pessimism regarding economic growth prospects. In the US, growing acceptance of the concept of secular stagnation has triggered a stampede into safe growth stocks and a flight from economically sensitive stocks.
  • The outlook for equity markets is predicated upon five key variables, including economic growth, corporate profitability, inflation, monetary policy, and broad financial conditions. Each of these factors appears favorable for stock investors.
  • The primary headwind to equity market performance relates to valuations, which appear modestly stretched at current market prices. The current price-to-earnings (P/E) ratio for the S&P 500 is 17.3, slightly above the long-term average of 16.5.
  • However, there is evidence of valuation extremes within a bifurcated domestic economy. Compared with an average P/E ratio of 22 for the S&P 500 Growth Index, the average P/E ratio for the S&P Value Index is only 15. Relative rates of return in future years will be predicated upon stock selection.
  • Fears of an asset bubble in common stocks are exaggerated. The compound annual return of 8.9% over the past two decades is actually slightly less than the 10% long-term average, implying a market in approximate equilibrium.
  • My forecast assumes equities will rebound in future months, with prospective gains within a range of 5% to 10% during the second half of this year, followed by gains of 8% to 12% in 2016. Stock market returns will likely be derived almost exclusively from growth in profits, with only minimal benefit from P/E multiple expansion.
  • The outlook for corporate profits is favorable through 2016, assuming more rapid economic growth, a moderate increase in unit labor costs, and improving business trends in Europe and Asia.  
  • The looming Federal Reserve rate-tightening cycle should trigger only a brief and temporary decline in stocks prices, consistent with the history of the past several decades. Stock prices should rise simultaneously with interest rates for a major portion of the tightening cycle.      
  • Future relative investment performance should be largely dictated by sector and individual stock selection. Industrials, transports, information technology, and financials should perform best; utilities, telecom, energy, materials, consumer staples, and health care should lag.  


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