News & Our Thinking

(St. Louis Post Dispatch) 

“Valuation is still fair to undervalued, but not nearly the bargain it was before,” says John Meara, president of Argent Capital Management in Clayton. “If you have earnings up single digits and valuation pretty fair, that’s how we get to the math that shows single-digit returns.”

January 3, 2016 (David Nicklaus)

If you were popping corks on New Year’s Eve, it probably wasn’t to celebrate your huge stock market gains.

The Standard & Poor’s 500 index ended last year 0.7 percent below where it began, with dividends boosting its total return to 1.4 percent. That’s paltry compared to the double-digit returns in five of the past seven years, but we may have entered an era where modest, low-single-digit gains are the norm.

Arithmetically speaking, the stock market boils down to profits and psychology, and neither force looks very powerful right now.

When the S&P 500 companies close their books on 2015, it looks like their profits will have fallen for the first time since 2008. Current estimates show a drop of 6 percent, mostly because falling oil prices wrecked the energy sector’s finances.

Most analysts expect a rebound next year, but think the sustainable rate of profit growth is just 4 to 5 percent. That’s also a baseline for what we should expect from the stock market — unless we collectively decide we’re willing to pay more for each dollar of earnings.

Investors currently pay $16 for every dollar of expected 2016 earnings. That number, called the forward price-earnings ratio, is close to its long-term average.

One could argue that the P/E ratio should be a little higher in today’s low-interest rate environment. With the Federal Reserve starting to raise rates, however, that argument isn’t as appealing as it was a few months ago.

“Valuation is still fair to undervalued, but not nearly the bargain it was before,” says John Meara, president of Argent Capital Management in Clayton. “If you have earnings up single digits and valuation pretty fair, that’s how we get to the math that shows single-digit returns.”

K.C. Mathews, chief investment officer at UMB Bank, is also in the low-expectations camp. He thinks this may be a bumpy year. “I think you’re going to see a lot of volatility around the Fed meetings,” Mathews says.

The economic news is likely to be “more of the same,” he adds, with slow growth and a gradually improving job market. “Why would you see (price-earnings) multiple expansion in this environment in 2016?” Mathews asks. “I don’t think you would. If anything I think you would see multiple contraction.”

Mathews thinks the stock market will do better than it did in 2015, but not by much. He expects a total return, including dividends, of between 3 and 6 percent.

Not everyone buys the slow-lane story. If you have faith in history, presidential election years are usually good for the stock market.

There’s also the contrarian logic that says the market always climbs a wall of worry. Stocks do best, it seems, when most people think they won’t do much.

“There’s a lot of cynicism and negative sentiment out there, but I would say there’s reason to be bullish,” says Darrell Cronk, president of Wells Fargo Investment Institute, who expects the market to rise at least 9 percent in 2016.

For one thing, the consumer is benefiting from cheap energy. “Rising oil prices are much more often a cause of recessions than falling ones,” Cronk points out. “With oil in the mid-30s, we should be thinking of that as nothing but a positive.”

There’s also enough money on the sidelines to fuel a rally. Investors withdrew nearly $170 billion from stock mutual funds in 2015.

Individual investors, unfortunately, usually have terrible timing. If you’re thinking about joining the exodus, you should ponder a couple of things.

First, the contrarians could be right, and you might miss out on a big gain.

Second, the alternatives to stocks aren’t great. Bonds lost money in 2015, as did commodities. Even during a flat year, the stock market wasn’t such a bad place to be.