Forecasting market performance is notoriously tricky. That would be true even if you were handed information about significant economic factors predestined to play out in the year ahead. Writing in The MoneyLetter, Toronto-based portfolio manager John Stephenson, president of Stephenson & Company Capital Management, posits that in the U.S. and Canada, recessionary risks are particularly low. He writes:
Imagine it’s January, 2014, and a soothsayer whispers in your ear that the coming year will feature a 50 per cent plunge in both oil prices and the ruble, along with contracting gross domestic product (or GDP) numbers in the U.S. and near-zero economic growth in Europe.
Given that information and asked to forecast the trajectory of North American markets for 2014, few investors would have predicted the S&P 500 composite index would post a total return of 13.7 per cent for the year. And yet it did.
For investors, what stands out about last year was the disparity between robust stock returns on the one hand and weak economic growth, falling rates, and low oil prices on the other.
On the rates front, treasury yields, in a surprise to everyone, managed to decline by 90 basis points in 2014, reflecting weakness abroad. (A basis point is one one-hundredth of one per cent.)
At the same time, corporate top-line performance contributed relatively little toward the market’s return.
The other surprise last year was that cyclical stocks broadly underperformed the overall market.
S&P 500: Expect double-digit gains
Dusting off my crystal ball for 2015, I am predicting another year of double-digit returns for the S&P 500 despite a modest economic backdrop. While I anticipate a small increase in the forward multiple for the S&P 500, I expect the bulk of a more than 12 per cent return for the benchmark index will come from accelerating earnings.
Although the American economy should grow at roughly three per cent this year, I expect global GDP to increase just 2.7 per cent. And, although central bank policy is likely to be at the forefront for many investors, I don’t think that even a rising U.S. Federal Reserve fund rate can disrupt the upward trajectory of the market.
Watching the central banks
Investors have been fixated on the various machinations of central banks around the world, seeing the actions of these institutions as key underpinnings of the equity bull market.
In the U.S., the Federal Reserve has finally ended quantitative easing and its language is becoming slightly more hawkish. In Europe, recent comments by Mario Draghi, the head of the European Central Bank, imply that policy easing lies ahead. Meanwhile, at the end of October, the Bank of Japan announced a massive expansion of its quantitative easing program. Together, these factors helped propel global equities higher.
Yet despite the widespread concerns over what central banks may or may not do, my research indicates that bull markets don’t falter because they become tired or expensive; they end when recessions ensue. I believe that in the U.S. and Canada, recessionary risks are particularly low.
Tax cut at the pump
The dramatic slide in crude oil over the last few months has been a boon for consumers. For consumers, lower gasoline prices act, effectively, like a tax cut.
Every penny that comes off U.S. gasoline prices puts about $1 billion in consumers’ pockets. With a slide of more than a dollar so far at the pump, Americans have another roughly $100 billion in spending power at the start of 2015.
And this is just the tip of the iceberg, as lower energy prices help reduce the cost other energy-related purchases (such as airfare) by an additional $200 billion.
American consumer versus U.S. energy sector
The dramatic slide in crude oil prices is unquestionably a good thing for the U.S. economy. Yet despite the overwhelming evidence of the benefits of falling oil prices many naysayers have pointed to the loss of investment and jobs as a result of energy’s slide.
Direct capital expenditures in the U.S. energy sector are just $30 billion per year. And even if you include knock-on effects such as energy services, you still are looking at annual contributions of energy of approximately $100 billion. This amount is tiny when compared with the $12 trillion contribution to the economy from the American consumer.
The U.S. has been creating roughly 250,000 jobs a month on average for the last six months. However, of that total, only nine hundred jobs per month can be attributed to energy. Even in energy states such as Texas, the vast majority of the jobs created have been in health care and education, not energy.
Conditions in place for U.S. consumer spending to rise
After six hard years of deleveraging, American consumers find themselves with personal balance sheets that are the best they’ve been in decades. Currently, there are a staggering five million job openings in the United States and wages have been steadily moving up. And that’s good news for retailers, as the correlation between wages and consumption, at 95 per cent, is very strong.
What I recommend
The U.S. economy is in great shape even as the outlook for global economic growth remains weak. With this as the backdrop to 2015, I’m focusing my portfolio solidly on the U.S. and, in particular, technology and health care stocks: two sectors that aren’t overly dependent on strong economic growth for solid returns.
In the health care sector, I continue to favour biotechnology stocks. However, my outlook is somewhat more tempered after four straight years of significant outperformance, in which essentially every mid- and large-capitalization biotech stock went up.
The fundamentals for the sector are still very solid, with many companies boasting innovative pipelines of exciting new drugs. Some of the areas that look the most promising for future blockbuster drugs are in immune-oncology, targeted cancer therapy and Alzheimer’s.
The industry should be able to continue to grow its revenues at a pace of 15 per cent to 25 per cent a year. This would outpace the expected performance of S&P 500 composite index, while merger and acquisition activity in the sector should help by putting a floor under company valuations.
Celgene: No longer a one-trick pony
One company that I like is Celgene Corp. (NASDAQ–CELG). A U.S. biotechnology firm, Celgene manufactures drug therapies for cancer and inflammatory disorders. For a long time it has been viewed as a single-drug company, anchored by its blockbuster drug Revlimid.
But Celgene is transitioning to a bigger story now that is focused on the pipeline of drugs it is developing. The company has more than 23 programs in place that could lead to future blockbuster drugs—and these are not yet factored into analysts’ estimates. I have a “buy” recommendation for Celgene and believe the stock could be worth $200 a share in the next year or two.
Biogen: Likely has the most upside potential among large biotech firms for 2015
Another biotechnology stock that I like is Biogen Idec Inc. (NASDAQ–BIIB). Headquartered in Cambridge, Mass., and serving markets around the world, Biogen specializes in discovering, developing and delivering therapies for the treatment of neurodegenerative, hematologic and autoimmune diseases.
Biogen likely has the most upside potential among large biotech companies for 2015. Its pipeline of development treatments is extremely strong. These include a multitude of programs targeting significant unmet medical needs with none of their current programs representing “me-too” therapies and all have potentially transforming value. I have a “buy” recommendation on the stock and a 12-month price target of $400.
Facebook: A massive user base plus attractive growth potential it has yet to tap
One smart way to play the anticipated strength in the technology sector is Facebook, Inc. (NASDAQ–FB).
Facebook sits at the nexus of some of the most important themes within the technology sector and boasts an impressive user base of 1.3 billion people. The massive amount of data the company collects from that huge user base is a unique and valuable asset for targeting advertising and content.
Facebook has many levers yet to pull to improve its share performance, including monetizing its Instagram service and greater integration of its WhatsApp acquisition. I have a “buy” recommendation on the stock and a 12-month price target of $92.
Conditions favourable for U.S. equities, especially tech, healthcare
Solid wage growth in the U.S., together with a likely rise in the Federal Reserve funds rate and a strong greenback make a compelling argument for holding U.S. equities.
True, macro uncertainty is likely to remain high, given the uncertainty around the future direction of Russia and the euro zone. However, stocks in American technology and healthcare benefit from strong secular (i.e., long-term) trends that should help insulate them from volatility.
The MoneyLetter, MPL Communications Inc.
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The MoneyLetter •1/22/15 •