[NEW YORK] Doug Ramsey, whose bearish research foreshadowed the U.S. stock market's first correction since 2011, says the rebound that has lifted equities since August doesn't mean the mispricings that drove the rout have gone away.
If anything they're worse, according to the chief investment officer of Leuthold Weeden Capital Management LLC, who says valuations are higher than when the selloff began because of deteriorating revenue and profits. The Standard & Poor's 500 Index is trading for 1.8 times sales, about where it was in August, while industrial stocks last week were priced at 20 times earnings, the most in more than a decade.
This is no message from a permabear. Mr Ramsey correctly called the broad rally in stocks that started in 2011. His call now that the S&P 500 will be 20 per cent to 25 per cent lower in 2016 from its record high in May underscores the concerns many have about the strength of the economy and the ability of companies to boost earnings, even with the unemployment rate having fallen to the lowest level since 2008.
"The correction didn't really solve a whole lot," Mr Ramsey said in a phone interview. "You have all the same underlying market fissures in place, yet they will have lasted another six months." To be fair, it's the same prediction Mr Ramsey made on Aug 23, and while the S&P 500 tumbled 3.9 per cent the next day, it quickly rebounded and climbed as much as 13 per cent in the next 12 weeks. That call was a rare misstep for the Minneapolis-based money manager in 2015 after he warned in early August that the "next big move in stocks should be down," citing weakening breadth.
"I'm the wounded bear up in the north country," said Mr Ramsey, who until 2014 was one of the staunchest advocates for the 6 1/2-year old bull market. "But I still think the odds are very high that the top was in May. I still think we're looking at a cyclical bear market."
The S&P 500 slid 3.6 per cent to 2,023.04 last week, its biggest drop since August, and is down 5.1 per cent from its record close of 2,130.82 on May 21. Since March 2009, American shares have almost exactly tripled, though they're down 1.7 per cent in 2015.
Valuations that have been above historical averages for months are being pushed higher as revenue and profits decline, Mr Ramsey said. After falling on a year-over-year basis in the first two quarters of 2015, revenue growth in the S&P 500 is forecast to contract 4.1 per cent in the third quarter. Until the first quarter of this year, the measure hadn't gone negative since 2012.
Profit expansion in the benchmark index has also ground to a halt. After earnings contracted 1.7 per cent in the second quarter, third-quarter income for the S&P 500 is now expected by analysts to decrease 3.7 per cent.
"Growth has been dismal this quarter, particularly when you look at revenue," said Skip Aylesworth, a portfolio manager at Hennessy Funds in Boston, where he oversees US$2 billion. "Underneath the surface, there are lingering concerns over the overall health of the economy. There's still a lot of uncertainty out there."
Forecasts for a plunge in equities run counter to the consensus view of Wall Street strategists. The median estimate of 21 surveyed by Bloomberg calls for the S&P 500 to reach 2,135 by year-end, up 5.5 per cent from its close last week.
Earnings are also projected to rebound. After falling in the fourth quarter, profits for S&P 500 companies are expected to increase 7.2 per cent in 2016 and 12.4 per cent in 2017, according to the estimates of more than 10,000 analysts for individual stocks. Should those come true, the index's price- earnings ratio would be about 4 percentage points below its level today.
"Valuation is not homogeneous," said Lawrence Creatura, a fund manager at Pittsburgh-based Federated Investors Inc, which oversees about US$350 billion. "There are certainly some very attractive pockets of inexpensively priced stocks right now. It's a great time to be a stock-picker."
Predicting earnings over periods of longer than a quarter or two is an inexact science and Wall Street often overshoots. At this time last year, analysts were calling for 2015 full-year profit growth of 7.9 per cent in the S&P 500. Now they see a decline of 0.3 per cent.
Other things are exacerbating investor concern and make maintaining the current level of valuation a challenge, according to Mr Aylesworth. First among them is the Federal Reserve's schedule for raising interest rates, which economists assign a 66 per cent probability of occurring in December. The more than 60 per cent drop in crude oil since June 2014 is also a headwind, he said.
Slowing growth in gross domestic product may worsen the earnings outlook, according to Tom Mangan of James Investment Research. The US economy expanded at a 1.5 per cent annual rate in the third quarter as companies took advantage of gains in consumer and business spending to reduce bloated stockpiles. That was down from a 3.9 per cent increase in the second quarter, and less than the bull market average of 2.1 per cent.
"It's going to be difficult for companies to engineer higher earnings without that stronger GDP growth rate," said Mangan of James Investment Research in Xenia, Ohio, which oversees about US$6.4 billion. "I don't fault anyone for taking some money off the table here. The stock market is not cheap."
BLOOMBERG
