~ By Michael Lombardi, MBA
Going into 2015, I'm not optimistic on stocks. I don't expect to see key stock indices perform anywhere close to how they did in 2014 or recent previous years. In fact, it wouldn't be a surprise to me if we see them decline for the first time since 2009.
I say this because there are many negative factors at play for stocks. The Federal Reserve has told us it will raise interest rates in 2015 and 2016. The Fed has stopped printing paper money.
There are troubles in the global economy. The use of stock buyback programs to boost corporate earnings can't go on forever. Stocks are overvalued when measured in terms of all historic stock valuation tools. And revenue growth for American companies, as I wrote in the last week of 2014, is hard to come by.
Take a quick look at this chart below and you will see the annual growth rate in stock prices is dissipating.
YearGrowth200925%201020%20116%201217%201314%20147.5%After a spectacular rebound from the March 2009 lows, starting with 2012, the annual growth in stock prices for the 30 Dow Jones Industrial Average companies has been declining. And corporate earnings growth (if you don't include the stock buyback programs, which prop up per-share earnings) is at its lowest level since 2009.
Over the past six years, key stock indices have been supported by the Federal Reserve's monetary policy. In 2015, the central bank is planning to raise interest rates—the federal funds rate—and has been very adamant that it will go through with this action.
In its most recent economic projection, a majority of the Federal Reserve's officials believe that the federal funds rate will increase to one percent in 2015, above two percent in 2016, and then to above three percent in 2017. In the long run, they expect the federal funds rate to be in the range of 3.25% to 4.25%. (Source: Federal Reserve, December 17, 2014.) While these rate increases might not sound significant, consider the current federal funds rate is 0.25%; increasing it to just one percent means a change of 300%.
With margin debt (money borrowed to buy stocks) at the NYSE near half a trillion dollars, when the Federal Reserve increases its benchmark interest rate, borrowing rates will increase, and investors who kept on buying on margin will come under pressure as the cost of borrowing rises sharply for them.
If this wasn't enough, when you look at the global economy, a global economic slowdown is becoming inevitable. Except for the U.S., all other major economic hubs are struggling. Look at China, Japan, and the eurozone. Their economic data is getting worse in these countries, not better.
In October of last year, the International Monetary Fund (IMF) said it expects the global economy to grow 3.8% in 2015. (Source: International Monetary Fund, October 7, 2014.) I believe these estimates are way too optimistic. When I look at indicators that tell me where the global economy is going, such as oil prices, they say a severe global slowdown is in play.
The global economy matters to key stock indices here in America because a significant number of these companies earn revenues from the global economy. In 2013, 46% of the S&P 500 companies derived revenues from outside of the U.S. (Source: S&P Indices, September 2014.) So as the global economy slows, their revenues decline, eventually hitting profits and stock prices, too.
As I have already reported here, 374 companies in the S&P 500, or 75% of them, bought back their shares in 2014. A company buying back its shares simply "financially engineers" better per-share earnings.
How long can companies continue buying back their shares? Revenue growth at large American companies is anemic. So to produce per-share earnings growth, companies have to either buy back shares (a move that will get more expensive in 2015 as interest rates rise) or cut expenses (which will hurt the economy).
I continue to push capital preservation. The upside for stocks looks very limited, while the risks on the downside are high. Key stock indices have increased far beyond their fundamentals and the higher they go, the bigger the fall is going to be.