Despite plunging macro data and stumbling earnings expectations, Deutsche Bank's (reluctantly less sanguine) strategist David Bianco notes that ECB QE, and a still accommodative Fed managed to push the S&P to 2100. However, as he explains below, policy normalization risks remain, particularly for the dollar and long-term yields. We don't see a quick recovery for oil prices. Strong job growth and falling unemployment despite still slow GDP suggests that Fed hikes are on the horizon and likely strengthen the dollar further. We see risk of a near-term 5-9% dip and reiterate the importance of sector preferences.
Via Deutsche Bank,
Ten Most Frequently Asked Questions By Investors:
1) How expensive is S&P? 17.8 trailing and 17.3 fwd PEs are 10-15% above history, median PE is high at 18.9. Trailing PE is 19.7 ex. 25 low PE mega-caps.
2) Is an 18 trailing PE sustainable and is there upside? Yes, if long-term Tsy ylds don’t exceed 3% the rest of the cycle. But at ~18x fwd EPS, future annual price gains likely only ~5%. Near-term, we see risk of a 5-9% dip as job gains make a midyear Fed hike likely, further boosting the dollar with more EPS cuts.
3) Which sectors have the most PE upside? Big-cap Tech and Health Care. The earnings share of Tech & HC in the S&P has doubled since 1980 to 33%. We expect these two sectors to lead S&P gains for the rest of this cycle on decent EPS growth (despite FX) and more PE upside; their PEs are in line w/ S&P now.
4) Which sectors and industries benefit from low oil prices and which suffer? Consumer Staples, Con. Discretionary and some Transports (Airlines) benefit; Energy, Capital Goods, Metals & Mining, many Chemicals and Utilities suffer.
5) Is the 10%+ record high S&P net profit margin sustainable? Yes, but likely at a plateau. We see margin pressures at Energy and Industrials partially offset by upside at HC and Cons. Discretionary. Financials margins should be flattish.
6) Are S&P payouts sustainable? Yes, but we expect a shift from buybacks to dividends over time. S&P pays out 63% via dividends + buybacks. We expect $400bn dividends and $450bn net buybacks in 2015 funded w/ an est. $850bn FCF. S&P has $1.6tr of gross cash and its net debt/mkt cap is at historic lows.
7) Have S&P companies driven EPS growth mostly with buybacks? Only 20% of S&P EPS growth or 1.6% is from buybacks since 2012. Net dollars spent on buybacks is running at ~2.7% of S&P market cap, but this overstates share count shrink and EPS growth impact given shares issued via option discounts.
8) How will equities (PEs) and long-term interest rates react to Fed hikes? We think the Fed hikes through 2016, but will signal intentions not to exceed 2% unless unit labor costs accelerate. Hikes can help limit the climb in LT yields and flatten the curve through 2016, if a stronger dollar keeps US inflation low and global real interest rates stay 0-1%.
We think this hiking cycle is nothing like any experienced before and the key to PEs will be how LT yields react. But in the meantime, EPS risk remains to the downside on FX, whereas the debate on magnitude of Fed hikes and how bond yields and PEs react will last all year.
9) Should small caps be bought into hikes and which ones? Small caps could outperform near-term if S&P avoids a dip. The R2’s PE premium vs. S&P and its history is still rich, but more reasonable on 2015 EPS given stronger growth than S&P. Industry tilts remain crucial. A flat curve will challenge small banks.
10) What’s the capex outlook? We expect near 5% capex growth within overall US GDP in 2015 with the big drop in Energy capex partially offset by better Tech spending. We expect overall S&P capex to be flattish at $700bn in 2015 with Energy sector capex (1/3 of total) down 15-20%, but up ~5% elsewhere.
* * *
EPS Revisions year-to-date are not positive...
Finally, Deutsche shows their "Seven Signs" is starting to tilt negatively... 2 Red (not safe/caution), 3 Yellow (neutral), 2 Green (safe). Key risks to stocks are a further slide in oil prices or Euro (EPS risk).
