Excerpted from the June issue of Provident Investment Management’s newsletter.
After strong market advances in 2013 and 2014, we have been bracing ourselves for a modest 2015. So far we have been spot on. The S&P 500 through April has advanced 1.9% for the year, currently down slightly from a fresh record on April 24. We also expected more volatility this year and that has come to pass as well, with January down 3%, February up 5.8%, March down 1.6% and April up 1%.
Why is the market so flattish and choppy? Elevated valuations coupled with uncertainty. According to FactSet, the S&P 500 now trades at 17.5 times the past 12 months of earnings compared to the 10-year average of 15.8. While this is only 11% above the average, the market is always looking into the future to establish today’s valuation and a combination of mixed economic data, a strong dollar, and flat corporate earnings is holding back a stronger advance. …
… Given the weak first quarter, investors now expect the Federal Reserve to hold off on interest rate increases. When examining federal-fund futures market expectations, investors see a 7% chance the Fed will increase rates in June, 22% in September, 38% in October, and 55% in December. We think the Fed might act sooner rather than later, particularly after Fed Chair Janet Yellen delivered a speech in early May that suggested stock prices were too high as investors take “excessive risks.”
We likened the speech to former Fed Chair Alan Greenspan’s December 1996 comments that the stock market was showing signs of “irrational exuberance.” After that speech, the bull market continued until March 2000. In any event, rising interest rates are a negative for the market and tend to reinforce volatility.
With the market at all time highs, we are finding it more difficult to find reasonably priced growth stocks. It is therefore more important than ever to do research and select great companies that can grow in any environment.
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