The bears are back!
A February 10th report from Deutsche Bank Markets Research highlights that a Fed rate hike in the second half seems likely. DB analysts David Bianco and Ju Wang also call for a 5%+ equity market correction in the near-term, projecting the S&P 500 will drop back to the 1950 level.
Fed hike and stronger dollar means trouble for US equities
Bianco and Wang say they believe the Fed will likely start hikes “around this June” given recent strong job growth and the tick up in labor inflation. This means a yet stronger dollar and a likely cap on any oil price rebound. Moreover, a stronger dollar will pressure EPS estimates across all U.S. multinational firms. The analysts note their end-2015 “S&P EPS of $120 is not a conservative estimate which assumes $1.10-1.15 avg euro and $55/bbl avg oil in 2015.”
The DB analysts also highlight that the energy sector is trading at 22.6x their end-2015 projected earnings of $70 billion. If you assume a fair 15x forward normalized earnings for the energy sector, the market is pricing in around $100 billion forward normalized annual profits, or a quick recovery of oil price to a sustained $70 a barrel level by the second half of 2015.
Bianco and Wang say oil won’t get near that price, and energy is overvalued even assuming significant cost structure reduction. They note: “We expect $100-$150bn of asset write-downs by Energy in 2015 (~$10 of S&P EPS), which on one hand reduces future depreciation costs to help EPS (but lowers earnings quality), but on the other hand weighs on PEs with weaker future earnings growth potential.”
S&P multiples too high, correction coming
The DB report also points out that the S&P PE is 15% above its historic average. Bianco and Wu predict a basically flat 2015 S&P EPS vs. 2014 EPS ex. bank litigation costs, and say double-digit EPS growth in US equities in 2016 is unlikely. This means the market is almost completely dependent on PE expansion to support share price gains.
Finally, the DB analysts note the 18x trailing multiple on year-end 2015 S&P EPS of $120 is 2160, and explain why they expect a 5% correction in the S&P 500 over the near term. “18x is not a multiple one should consider undemanding with upside merely depending on absence of negatives. We think a 10% upside is something most investors would want to earn given that it depends on an 18x trailing PE with the near-term Greece and Russia/Ukraine keeping Europe’s green shoots at risk, China’s slowdown in progress and continued rate, FX and commodity volatility (high VIX). We see S&P 500 likely to revisit ~1950 level in the near term, which makes for 5% downside from here to put market at a reasonable reward/risk. We reiterate our tactical call that the next 5%+ move of S&P 500 is down.”