It is challenging to write an economic update with the “Grexit” story changing each hour, Chinese stocks in a free fall, and technical glitches at United, NYSE, etc. seeming particularly suspicious. The Freedom of Information Act, along with our competitive news media market, provide some comfort, but there is no way of knowing what the Eurozone or markets are going to look like at the time you read this.
Returns and Valuations by Style
What happened in the markets in the second quarter? Not much. More importantly, let’s look at the Forward Price to Earnings ratio on the right hand side of the chart. We are in the seventh year of a bull market and P/E ratios are slightly above their twenty-year average for domestic value stocks while growth, or “momentum stocks” are still undervalued. Ironic? Perhaps we are still a little nervous after experiencing a loss of approximately half our investable assets twice within the last fifteen years.
Sources of S&P 500 Earnings
No matter what happens in Greece, economists are projecting a $4 loss in earnings per share for each quarter for the S&P 500 Index from a strong dollar and low oil prices. Long term, the strong dollar, up 17.8% year-over-year, is projected to decrease GDP over 1% with an offsetting benefit from lower oil prices. Going back to earnings, we know that valuations matter and they have a strong correlation to five-year returns. If earnings don’t increase as expected, the market doesn’t have much room to grow.
Long-term drivers of economic growth
As we’ve discussed before, the U.S. has a demographic disadvantage to emerging economies. Growth in real GDP is dependent on growth in the working age population and an increase in productivity. According to the Census Bureau, the forecast for the increase in civilian working age population is a dismal 0.4% growth over the next ten years as the Baby Boomers move into retirement. Investment in nonresidential fixed assets has been recovering from the global financial crisis but the long-term GDP forecast is hovering around 1.5%.
Conclusion
As usual, we recommend a balanced portfolio with a risk profile suitable for each investor’s tolerance. The current headlines may be a case of the tail wagging the dog. Global growth still has a solid foundation and the U.S. is expected to reach full employment in 2016. Slow but steady growth is on the horizon.
Castle Rock Investment Company, formed in 2006, is an independent woman-owned SEC-registered investment adviser located in Castle Rock, Colorado. We specialize in individual financial plans and qualified service plans.