Wall Street in 2016: Clear new trading signals are still missing

Shortly before the turn of the year, the frame data, which made 2015 a below-average year for the U.S. stock market, has not changed much. In such an environment, shares which offer growth at a reasonable price promise the best results in 2016. 

The current bull market, which hopes to celebrate its seventh birthday in March 2016, might be held responsible for two kinds of wrinkles on investors’ faces. On one hand, it may have caused laugh lines because the S&P 500 Index has more than tripled since March 9, 2009. However, on the other hand, the bull market might also be responsible for several worry lines as there was never a lack of new trouble spots since the financial crisis that started in 2007/08. 

Also, currently there is no shortage of problems. That, however, is not necessarily a bad omen, since stock prices in the past few years moved upward on a wall of worry. But at the same time, it is striking that the factors which accompanied the sideways trend of the S&P 500 Index and the Dow Jones Industrial Average in 2015 are still dominating the market environment.

These include, for example, relatively high valuations, moderate growth expectations for the economy, comparatively high profit margins and a strong U.S. dollar, which makes it harder for exporters to do good business.  

In addition, the number of non-performing corporate loans has clearly risen, and the turnaround in the U.S. interest rate cycle causes a lot of uncertainties in general. Even the booming M&A business can be seen as a double-edged sword, since the record high deal volume can also be a warning sign for too much complacency in the corporate sector. 

 

Economic development and company profits decide 

The interest rate policy should become critical only if interest rates rise more quickly than previously planned. Currently this seems unlikely, but it could become an issue if the slowly emerging wage pressures show inflationary effects in 2016. Otherwise, it is very important to pay attention to the direction the economy and company profits are taking: If there is no recession, the danger of a new bear market for stocks can be considered as rather low. Therefore, it is encouraging that the helpful Conference Board’s Leading Economic Index does not yet show any warning signs. After rising in October and November, the LEI remains in an upward trend.  

Perhaps that is an important reason why stock market strategists predict on average a gain of around 10 percent for the S&P 500 Index. 

Nevertheless, now is not the time to sit back and relax. With reference to the weak growth in many emerging markets, renowned U.S. economist David A. Levy does not exclude negative impacts on the United States. In addition, the director of the Jerome Levy Forecasting Center recalls the current earnings weakness of U.S. companies. While Levy is skeptical about whether profits can improve, the analyst consensus for 2016 expects earnings growth rates in the mid- to single-digit percentage range.

But given the aforementioned frame data, it remains to be seen whether these hopes will be fulfilled. If positive earnings fail to materialize, rising stock prices could become difficult to achieve. In that context, it should also be recalled, that excluding the late 1990s/early 2000s bubble period, the market has been unwilling to push the median P/E for S&P 500 stocks above the 22-24 range. With a current median P/E of 22.2, multiple expansion could prove difficult, according to Ned Davis Research. 

The market outlook for 2016 in the wake of the next presidential election in November cannot be ignored. But with an average post-war gain of 6.6 percent during election years in that respect, there is no general cause for concern. However, it would not come as a surprise if politics were to slow down the stock market during the first half of the year. This was a typical pattern in the past during the first six months, as well as a stronger second half.  

“The market hates uncertainty, and political uncertainty is no exception,” says Ed Clissold, U.S. strategist for Ned Davis Research. He assumes the following: “The timing of an election-year rally may depend on when the winner of the presidency is well known, regardless of party.” 

Leading stock indices still trapped in sideway trends 

In general, long-term investors should not make their investment decision too dependent on political circumstances. Instead, it should prove more promising to focus on the fundamentals and the chart signals. With regard to the latter criteria, a new general buy signal for the market as a whole would be generated if the leading indices like the S&P 500, the Dow Jones Industrial Avarage or the Nasdaq 100 broke out to new highs.

A dip below the still prevailing sideways trend would instead trigger a sell signal. With regard to sectors, the skeptical view of Savita Subramanian of the applicability of sector overweights and underweights in the current market environment sounds plausible. “Every sector today comes with plenty of ‘hair’ – if not macro risk, it has disruptors, negative headline risk, is too crowded or too expensive.  

“We believe investors should focus on themes and stocks, not sectors,” says the BofA Merrill Lynch U.S. equity strategist. 

 

Oldies but goodies 

Old-fashioned stock-pickers, who don’t believe in market timing, should concentrate on stocks with an attractive investment story, valuations that have not gotten out of hand and that are trading in existing upward trends.

Within the 30 Dow Jones components, these requirements are fulfilled by General Electric, Microsoft and the insurance company Travelers Companies. Earnings growth for a reasonable price can furthermore be found in companies like Avago Technologies (semiconductors), Southwest Airlines (low-cost Carrier), AbbVie (biopharmaceutical), Goodyear (tires) and Aetna (health insurance).

All of these stocks have a price-earnings to growth ratio of around one or even under one. That is a favorable valuation multiple in a low-growth world, which should be rewarded by market participants if the mentioned companies can successfully stay on a growth path. 

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