October 2016 Monthly Outlook

by on Oct 4, 2016 Categories: monthly outlook, us economy, us stock market

Economic Commentary:

Employment held stable with the August jobs report showing that 150,000 new jobs were added. All other economic indexes dropped in August. Further inflation is starting to tick up, as the core consumer price index increased 0.2% in August. This could put pressure on the Federal Reserve to raise interest rates despite the sluggish economic growth. Long term interest rates increased slightly in September as the 10 year government yield increased 4 basis points to 1.61% at month end.

The Conference Board Leading Economic Index® (LEI) for the US decreased 0.2% in June to 124.1. “While the U.S. LEI declined in August, its trend still points to moderate economic growth in the months ahead,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “Although strengths and weaknesses among the leading indicators are roughly balanced, positive contributions from the financial indicators were more than offset by weakening of non-financial indicators, such as leading indicators of labor markets, suggesting some risks to growth persist.”

 

Indicators point to the US economy growing slowly (~2% annually) and being in the late stages of a long business up-cycle without major excesses that brought down some prior economic upturns.


Stock and Bond Market Commentary:

The S&P 500 was flat again in September, but ended the quarter up over 3% and is now up more than 7% YTD. Stock valuations continue to be very rich. These valuations are based on the sell side equity analysts’ estimates for earnings to grow 15% annually the next two years. In other words, analysts are justifying the current valuations based on their assumption earnings will be 30% higher two years from now. In my opinion, this assumption is hard to believe considering we have not seen earnings growth anywhere near this rate during this economic recovery since 2008, and earnings growth has been flat for the past two years. Further, even if earnings did grow 30% the next two years, stocks would only then (in 2 years) justify trading at the current levels. Even if we do see 30% earnings growth in the next two years, you may not make any money from stocks as this growth is already priced in. Based on these assumptions, I think it is highly probable that future stock returns will be lower than the historical average of 8% annually. However, I do not foresee a significant decline in the stock market because other investment options are less likely to offer comparable returns – savings accounts provide no yield and real estate is just as overvalued (if not more so) than stocks.

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