The S&P 500 finished the year with a total return of 14% (11.4% price appreciation and 2.3% dividends), and investor sentiment hasn’t been this high since… the beginning of 2014 (must be something about the holidays). Last year we saw sentiment collapse during the spring sell-off, and Goldman Sachs analysts David Kostin, Amanda Sneider, and Ben Snider are predicting a modest 4% total return for the year, so investors may want to watch their US stock portfolios carefully.
S&P 500 PE multiples could contract after Fed rate hike
Kostin, Sneider, and Snider expect to see the S&P 500 index go up 4% by the middle of the year, but that PE multiples will start to contract in the second half after the initial Federal Reserve rate hike (which they are guessing will happen in September), pulling the S&P 500 forward PE down to 16x. They expect dispersion and volatility to remain low, though it should be higher than the 30-year lows that we saw last year.
To make the most of what looks like it will be a more difficult trading environment, the Goldman Sachs report recommends focusing on US stocks with high domestic sales, strong buybacks and dividends, and low turnover. They point out that the top 25 stocks accounted for 47% of the S&P 500’s total returns, though that doesn’t mean you want to start buying into those stocks now.
Sector valuations at the start of the year
Last year’s 14% total return was above average for the S&P 500, but not significantly so (2013 was more than a standard deviation past the mean). The top five performing sectors in both absolute and risk-adjusted terms were utilities, health care, IT, consumer staples, and financials (though the exact order moves around), while Brent crude is the worst performing asset by either measure, to no one’s surprise. Barclay’s 7-10y Treasury ETF and Russell 1000 Value also ranked highly for risk-adjusted returns.
Financials and telecoms are the cheapest sectors starting off the year, with PE multiples of 14.4x and 13.8 respectively. Energy is still valued at 16.1x, even though the prospect of continuing low oil prices could wreak havoc. Consumer staples is the most expensive sector by PE at 19.3x, as well as the most expensive by price-to-book at 4.9x, well above the S&P 500’s overall 2.8x PB.