There are many reasons to worry about this market: Russia, Greece, oil volatility and bond market mis-pricing Fed hikes are a few of the macro risks. I do think that oil will ultimately be a net positive for the U.S. economy, but with increased volatility in the short-term. The two factors which I am worried about now are the mis-pricing of Fed hikes and stagnant earnings growth.
The mis-match between the Fed Fund futures market and the Fed's own hiking expectations is concerning. If the bond market has a violent selloff due to a re-pricing of the timing of Fed rate hikes, this will also cause a selloff in equities. Now I don't think the Fed will repeat a 1994-like tightening. But I do think 1994 is helpful to understand the risks of a bond market which is mis-priced relative to the Fed's own hiking intentions. The S&P was only down -1.6% in 1994, but the S&P did have a top to bottom sell-off of -9.7% from Jan 31 (ironically) to April 4.
The second issue on my mind is earnings. The Q4 earnings which have been reported and expectations for those not reported yet sums to $29.51 for the S&P. This is only up 4.5% from Q4 2013. But it gets worst. Q1 earnings expectations are $27.98, up 2.4% and Q2 $29.99 up 2.2%. Obviously, energy is a huge part of this. The earnings of the energy sector was down -13.1% in Q4. Energy earnings is also expected to be down another -54.3% in Q1 and 51.8% in Q2. Is energy the only area of weakness? The table below shows the quarterly earnings growth of the S&P and sectors on a year-over-year basis.
So there are obvious pockets of weak growth in energy, financials, telecom and utilities. Where is the strength coming from? Health Care and Tech. The health care sector is probably pretty insulated from the oil shock and other macro economic issues. Tech on the other hand has more risk due to the more cyclical nature of it's business.
I am also concerned that the pickup in earnings growth in the second half of 2015 is more wishful thinking than credible forecasting. So if earnings growth has shifted down into the low single digit range, should the market multiple also contract? So far this year we have seen an expansion of the market multiple because the market is down -3.1%, but forward earnings expectations are down more.
Michael Grove, CFA