Happy New Year! The S&P500 was up over 11% for 2014 completing the third straight year of gains in excess of 10%. The last time this happened was in the late 1990’s. So where do we go from here? Many would argue that much like the late 1990’s, the bull market must be near the end. Now, however, is a very different time. The internet technology revolution of the late 90’s created valuations that were unsustainable. The market traded at nearly 30 times corporate earnings which in hindsight, created the “tech bubble” that started to unravel in March of 2000. Today the market is not trading at exorbitant prices relative to earnings. Prices are at about the average price to earnings ratio since 1986 of 16.7 times.
Corporate earnings continue to improve, interest rates remain low and unemployment is falling. Nonfarm Payrolls have been far better than expected the last two months including today’s December announcement of 252,000 new jobs which was above estimates. Economic growth has accelerated recently as measured by the Gross Domestic Product (GDP). GDP increased at an annual rate of 5.0 percent in the third quarter 2014 and 4.6 percent in the second quarter. This level of growth should produce sustained corporate earnings growth.
At current equity valuation levels and with an improving economic outlook domestically, we do not see the potential for recession which is the basis for bear market conditions. Bear markets typically begin when a recession is perceived imminent and when valuations are stretched which is far from the case now. However, we do anticipate in increase in volatility for 2015. There will likely be some anxious moments like we saw last October and in the early part of December. Through it all, we remain bullish intermediate to longer term and would caution against making emotional decisions along the way. Overall we anticipate another year of market gains.
The lack of a Santa Claus rally defined as a bullish period over the last five days of the year through the first two trading days of the New Year does cause concern for some. This was the case both in 2000 and 2008 which, of course, were down years. However, the last day of the year and the first day of the New Year were down. Seven of the ten times this has happened since 1980, the market ended with an average annual return of 7.2%. Four of those years were some of the best years with double digit returns by years end.
Fun to think about: When you look at S&P500 rolling 10-year average returns, we are about to cross through the 10% level to the upside which has not happened since 2003. This occurred two other times; 1950 and 1983. It happened near the beginning of sensational bullish advances. Stocks added an average of around 15% a year for the next decade. Of course, we are not predicting this but; it would not be out of the question for those that believe we entered a new secular bull market when we broke to new highs back in 2013.
We will remain optimistic for several reasons: Earnings are still growing and are reasonably valued, interest rates remain low, the economic outlook is improving and, we would argue that there is still a lot of skepticism. The bull market stage consisting of an abundance of optimism or even exuberance that would be unfounded is not visible for now.
As always, thank you for your trust and confidence.
Royal Fund Management