2015: Outlook for Stocks, Bonds, Commodities, Currencies and Real Estate

Recommendations

1

Predictions for 2015

As you can see, my outlook is quite bearish for the rest of 2015.

The Down could fall below 15000 by the end of 2015.

I am expecting a steep fall in global stock prices between:

a) 17th September 2015 to 25th September 2015

b) 9th October 2015 to 16th October 2015

c)20thOctober 2015 to 11thNovember 2015 (steep fall)

d) 17th November 2015 to end of 2015

I am expected strong global stock market rally between:

i. 7th September 2015 and 16th September 2015

ii. 28th September 2015 and 2nd October 2015

iii. 19th October 2015

iv. 12th November 2015 to 16th November 2015

12th November to 16th November 2015–in particular, banking stocks will boom and zoom between this periods.

Last time in the rate rising cycle, the Fed was unable to control long term interest rates.

The basic premise of stock markets currently is that growth is slowing in almost every corner of the world.

Thus, earnings are not meeting expectations from NYSE to FTSE to Mumbai.

Bond markets have been on roll in consonance with this.

The Greek drama and the Chinese stock market meltdown have taken away most of 2015 till now.

Reluctantly the Greek Parliament has accepted the terms and conditions laid down by its creditors so that Greece could remain part of the Eurozone.

The decision from the People’s Bank of China (PBoC) to devalue its currency caused the largest fall in the yuan in over two decades.

The reasons behind China’s downturn and likely recession are familiar from the long history of business cycles everywhere: rising excess capacity in a growing number of sectors, excessive leverage in the private sector and episodes of irrational exuberance in asset markets.

And while the decision of the PBoC to devalue the yuan might signal how desperate China has become after reporting a drop in exports of 8%, it doesn’t exactly spell disaster for U.S. companies.

People sometimes over-estimate trade linkages. Although imports into China are down 15% this year, the slowdown has been happening for some time. Besides, the impact beyond commodity producers is small… in fact, there could be tremendous benefits to commodity importers.

Two-thirds of the revenues of U.S. corporations are domestic. So the real driver of the economy, and the market, is really domestic demand and there is some evidence [with] the job market improving in the U.S. that things are getting a little bit better.

But with slowing sales growth and modest economic expansion, capital spending and corporate repurchases would only be able to contribute so much of a boost against new headwinds to keep the market where it is.

While a weaker yuan can hurt U.S. multinational companies’ exports, growth in China has been largely infrastructure driven, which draws in commodities but not consumer goods.

Valuation, lack of earnings growth, Fed hike on the horizon–that’s sort of the see-saw [that] basically leads you to ‘flat is the new up. You should be expecting that kind of a return in this market.

The fall in commodity prices underscores the need for any country to have a well-diversified economy and not merely be dependent on commodity exports for its sustenance.

I see more possible turmoil in the world. We have had no economic problems in the last six years (after the financial meltdown of 2008–2009 in the US) and it (turmoil) is long overdue.

Dow Jones Industrial Average could end the year 2015 below 15,000. The FTSE could end 2015 below 5800. The Japanese Nikkei could end the year closer to 15000. Mumbai SENSEX could end 2015 around 23,000. And the Shanghai Composite Index could end the year closer to 2800.

As regarding investment destinations of choice; when I speak around the world I tell them there is only one country where you have business opportunities and that is India. There is no country in the world with a range of man-made and natural sites, the religions, the languages, the food… I love it.

If not anything else, market dependency rather than data dependency will ensure that the US Federal Reserve will stay put in September 2015.

And if the Fed does stay put on September 17, as I believe it will, this will further add to uncertainty and could end up roiling stock markets.

Rate Anxiety Lands at Worst Time in Six Years for U.S. Earnings

Federal Reserve rate hikes haven’t been a bullish signal for U.S. corporate profits in the past. That’s bad news for investors banking on a rebound from the first quarterly retreat in earnings since 2009.

Since World War II, the median rate of growth in profits has decreased markedly when the Fed raised rates, falling by roughly half in the year after an increase.

Any further slowdown in earnings is unlikely to sit well with investors who just endured the first 10% correction in four years.

The market has been priced for perfection, and that even includes the effect of fairly optimistic assumptions for earnings growth. If the relationship about the Fed rate hike holds, then that disappointment could be much bigger than anyone is currently expecting.

One of the reasons profits weakened after the Fed acted in the past is that rate hikes usually come after a period when they’re booming. The median pace of earnings expansion in corporate income was about 16% in the year before rate increases, compared with 7.6% normally.

Normalizing Policy

In the S&P 500, gains in quarterly profits have averaged 3% since the third quarter of 2014, down from 17% since the bull market began. Like elevated volatility and the unusual length of the bull market itself, the rate of earnings growth is another example of how the Fed is preparing to normalize policy at a time that is anything but normal.

If you look at the timing of Fed increases, it typically comes after the peak of the rate of corporate profit, because they’re responding to the rate of growth. This time around, everything is growing slower. That’s why I am predicting a lethargic stock market for the next three, four years.

Profit expansions have slowed to a median 9.3% in the year after a tightening cycle starts, down from 15.7% in the period preceding one. The deceleration is more pronounced in the two quarters on either side of the increase, when the rate of growth falls to 3% from 14%.

One reason earnings suffer is that higher borrowing costs are initiated to slow an overheating economy while costs for everything from labor to equipment are rising. Rate hikes will underpin a stronger dollar, whose 15% ascent in the past year has hurt sales for multinational firms.

Expectations Game

The response of other economic factors could affect earnings if people change their behavior in anticipation of what the Fed is going to do. It’s all about the expectations of business owners, an expectations game that the Fed has to take into account.

Record-low interest rates pushed the cost of servicing debt for companies in the S&P 500 to an all-time low of 3.5% of sales in the past 12 months. The decline from 7.4% in 2007 represented $310 billion in savings and contributed to a doubling of profits and a three-fold increase in stock prices.

If you’re taking a longer term approach, tailwinds companies experienced in terms of low borrowing and low labor costs may start to abate. In coming years those could become headwinds.

History shows that once negative earnings quarters start to pile up, they keep going -and the effect on investor sentiment is hard to arrest. Nine months tends to be the threshold: Among 17 declines that have lasted three quarters since the Great Depression, exactly one stopped there, in 1967.

Among S&P 500 members, combined quarterly profit growth has turned negative in 33 instances since 1937, data compiled by Bloomberg and S&P Dow Jones Indices show. While half of them lasted no more than six months, the others almost always dragged on, spanning five quarters on average. Out of the 17 occasions where earnings fell for at least three quarters, 14 occurred within three months of a bear market.

Analysts forecast profit will fall for another two quarters, sinking 6.2% during the current the period and 0.8% in the final three months of 2015.

With companies already struggling to match last year’s levels of profitability, any harm from the Fed’s rate increase may make it harder for executives to wring up profit.

When will Fed hike interest rates?

Futures market implies that the chance of a rise in September 2015 has dropped to only about 30%. This is largely because of the shocks from China over the summer of 2015, as Beijing was widely held to botch its reaction to a stock market fall and its decision to allow its currency to devalue, while evidence mounted that its economy was slowing seriously.

So far the Fed has been dependent only on US economic and market data. But seeing the turmoil in August and the interdependency between markets, movements in an economy on the other side of the world could also influence.

If China’s economy continues to slow, exporting deflation with it, then the chances is that the Fed will continue to keep US interest rates at zero for the rest of 2015 and beyond.

There is also a sense in which foreign events could help do the work of monetary tightening. China’s long drawn-out accumulation of reserves – dubbed the Great Accumulation – is coming to an end. Global foreign exchange reserves, after a long period of increases, have started to decline.

China’s August devaluation came after it had spent time selling reserves to prop up its currency against the dollar.

In the last decade, reserve accumulation arguably kept US rates low. The Fed under Alan Greenspan raised rates repeatedly, but failed to push up the long-term bond yields that underpin credit markets, and failed to avert an ultimately disastrous credit bubble. Mr Greenspan himself described this as a conundrum – and many believed that it was driven by heavy Chinese buying of US bonds, which pushed their yields down.

If China’s slowdown now means that it will have to start to sell some of its US bonds, it is at least possible that the effect will now work in reverse. Selling bonds directly pushes up their yields. Meanwhile, counter intuitively, there has been a marked correlation between reserve accumulation and the dollar.

As reserve managers accumulate dollars, they tend to diversify them into other currencies, such as the euro. This weakens the dollar. So as investors watch China even more closely, the risk that a slowdown there thwarts a rate rise in the US could be counterbalanced by the effect of reducing its reserves, which will push up the dollar and US bond yields – and do some of the work that would have been done with a rate rise.

Although I am not bullish on the rest of 2015, I am enclosing a few investment ideas at the end of this book indicating places an investor could look into for little more than average returns.

Once the market settles, these investment ideas could be used to further advantage.

2

Does fall in Apple price bode ill for the bull market?

Customers browse in an Apple store in Sydney

Apple, the world’s most valuable company with a $658bn market capitalisation, is losing its lustre with the stock price having fallen nearly 13% since mid-July.

The maker of iPhones, iPads and Mac computers has been a stock market darling during the current bull run and dominates investment portfolios.

A seven for one stock split in June 2014, resulting in a much lower price, only bolstered the appeal of owning Apple among retail investors and helped pave the way for the company being invited into the Dow Jones Industrial Average in March this year.

Why is Apple’s stock under pressure? Signs of slower growth in China have rattled investor sentiment and this comes in spite of chief executive Tim Cook’s bullish outlook for sales in the country in a recent earnings call.

Although Apple more than doubled China sales to nudge third-quarter revenues and earnings just ahead of market forecasts, investors were rattled as iPhone sales fell short of expectations.

Apple has lost its position atop the Chinese smartphone market to upstart Xiaomi during the second quarter.

What has happened to Apple’s stock price? Apple climbed to a closing peak of $133 in February, only to consolidate in a range until mid-July.

Selling pressure pulled the stock below important measures of momentum, known as the 50- and 100-day moving averages.

That was apparently enough to accelerate selling, particularly in a market dominated by algorithms that quickly react to such signals and can exacerbate trends.

The stock has since dropped through the important 200-day moving average, a measure not breached since September 2013, reinforcing just how bearish the price action has become. After opening nearly 1% higher on Thursday, sellers emerged and the stock closed 0.2% lower in New York.

That leaves Apple’s stock 4.3% higher this year, handily beating both the DJIA and S&P 500, but trailing the Nasdaq Composite.

But the big question now is whether Apple is set to repeat its late 2012 decline, which resulted in the stock retreating from $100 to $55 (after adjusting for last year’s stock split) over seven months.

How does a lower Apple price influence the broader market? Apple’s share price slide has weighed heavily on broader indices with every $1 change in Apple’s share price resulting in a 0.65 point shift in the S&P 500.

In the price-weighted DJIA, Apple only ranks as the fifth-worst performing stock over the past month.

In terms of importance, Apple’s current stock price of $115.13 means it trails many other companies that have higher prices, led by Goldman Sachs at $205, followed by IBM, 3M, Boeing, United Health and Home Depot.

Why should the slide in Apple worry investors? Apple has dominated the bull market that began in March 2009. Indeed, it has risen 870%, outstripping the S&P 500’s rise of 210% and a gain of 341% for the Nasdaq 100.

It has also become a huge payer of dividends and buyer of its own stock, bowing to pressure from activist shareholders to do more with its pile of cash.

This year Apple said it would expand its dividend and buyback schemes to return $200bn to shareholders by the end of March 2017, up from the $130bn programme of a year ago.

That includes a further $50bn in share repurchases and an 11% dividend increase.

But this ageing bull market looks vulnerable and many highlight how this year alone leadership has resided in a handful of stocks.

Just seven account on their own for all of the sub 2% rise in the S&P this year – Amazon, Walt Disney, Google, Gilead Sciences, Facebook, Netflix and, yes, also Apple.

So we may well be seeing one of the cornerstones of the bull market sending investors a very important message.

3

The world of finance as it stands today

Four themes are at play: US rate rise, China, European recovery and oil

I believe it is prudent to look at the performance of the world stock indices since the end of the Great Recession in March 2009. It gives you an understanding of what has transpired and what lies ahead.

A Longer Look Back

Here is the same chart starting from the turn of 21st century. The relative over-performance of the emerging markets (Shanghai, Mumbai SENSEX and Hang Seng) up to their 2007 peaks is evident, and the SENSEX remains by far the top performer. The Shanghai, in contrast, formed a perfect Eiffel Tower from late 2006 to late 2009.

For those tracing the cause of August’s rout in world stock markets, most roads lead back to China.

The negative investor reaction to the fall in the renminbi and dark talk of currency wars quickly gave way to very real concerns about China’s economic strength, compounding the negative mood. Yet for all the prevailing attention on China, there are actually four themes that will set the agenda for asset allocators as we roll into autumn.

First, the timing of the US Federal Reserve’s rise in interest rates will continue to captivate investors. A rate rise this year is highly likely, on the grounds that the US job and housing markets remain robust, even if inflation continues to lag.

Typically stock markets struggle over the first rate rise. They have historically dipped 5% on average in the three months after a rise, before regaining their poise and outperforming bonds for the remainder of the hiking cycle.

Given the focus on the US rate cycle, and the de-risking prompted by events in China, markets arguably have already discounted much of the weakness normally seen at the start of a rate rise cycle. After all, if the US economy is strong enough to justify higher rates, and it is only the recent market volatility that is staying the Fed’s hand, the start of the cycle should be taken as a signal of normalisation.

History tells us investors should dump stocks on the last rate rise, not the first; cautious optimism on stocks, and a clear buy the dip mentality, is still a sensible base case.

Second, while a softening China will not derail global growth, it still has far-reaching global implications. China is in the painful process of trying to move from an investment-led growth model to one driven by consumption. Market liberalisation efforts, such as moves towards floating the currency, are fundamental to this process.

There is real and concerning weakness in China, but the notion that the renminbi’s drop in value constituted the opening salvo in some global currency war is far-fetched.

Far more profound is China’s reduced demand for commodities, a secular issue that will weigh meaningfully on emerging markets for some time. The ramifications extend beyond traditional commodity producers because the structural decline in commodity prices is likely to affect many policymakers’ outlook for inflation.

Third, the European recovery and the aftershocks of the eurozone periphery crisis will remain critical. We should not play down the hard road that Greece has ahead, but that has little bearing on Europe’s broader economy. A bigger issue will be how the eurozone works through heightened political uncertainty – notably the Spanish general election due late in the year.

Despite recent volatility, European equity earnings growth is outstripping the US for the first time in five years, albeit from a much lower base. Economic sentiment in the euro area remains optimistic, and continued improvements in credit conditions should reinforce the domestic recovery.

Significantly for Europe, where around four-fifths of corporate financing comes from banks, lending growth relative to GDP is at its best level since before the financial crisis, adding further support to equity markets for the next 12 months.

History tells us investors should dump stocks on the last rate rise, not the first

Fourth, the double dip in oil prices will drive the global markets agenda. Weak oil, especially in combination with a strong dollar, is not helpful for US equities earnings. If we account for the effect of oil and the dollar, US earnings will have gained little ground this year. The bad news is we have forgone a year of earnings growth; the good news is that even though it is a contrarian view, I expect oil to rebound over the remaining of 2015.

Based on the factors discussed above, there are two areas of conviction.

First, short-dated US interest rates look to be headed higher, providing continued support for the dollar, and potentially putting still further pressure on EM economies.

Second, I expect downside in global stock markets to gather momentum over the rest of 2015 (barring few pockets of strength) which I have included in my above time-table.

No storm is perfect, but this one has been pretty good.

Severe and sudden foul weather in the markets almost always has several different forces feeding it energy.

In this one we’ve had, broadly speaking: Severe stress in China, emerging markets, commodities and credit markets, plus concerns about the Fed’s liftoff plan hovering above, providing independent reasons for investors to shed risk.

Together they’ve made quite a stir. And add to all that the fact that the typical safe stuff hasn’t acted the way the fancy investment models predicted – with Treasury bonds and the US dollar failing to rally. So to some unknowable degree, the slight by these model-driven funds for higher ground has punctuated the action.

The crucial question is not why it all happened, but whether the S&P 500’s 12% drop was just about enough to expend most of this dangerous atmospheric energy?

Let’s look at a few incoming signals to help shape an answer:

Stocks have, abruptly and belatedly, caught down to other asset classes, which had been weakening for months before the S&P 500 (^GSPC) broke below its long-held trading range.

The US equity market is now pretty much in line with where it should trade based on conditions in both high-grade and speculative corporate bonds.

That doesn’t mean stocks won’t overshoot, or that credit won’t weaken further, but it suggests that stocks are no longer whistling past the graveyard.

Small investors have purged stocks in favor of cash and hedge funds have placed record bets on further extreme market volatility while bingeing on other forms of downside protection too.

The move by commodities giant Glencore (GLEN.L) to end its dividend and issue more stock resembles the kind of desperate action that occurs in panic but nowhere near bottoms.

And a recent Wall Street Journal article expresses alarm that many foreign-stock funds own quite a bit of emerging-market stocks. Imagine that. When a major asset class is portrayed as a toxic hidden ingredient in otherwise wholesome product, we’re usually well on our way to washing out all but the strongest owners.

At the same time, the market uptrend is broken and most chart watchers don’t trust the tape. They see plenty of repair work necessary, are telling you to sell rallies – such as the one this morning - and don’t believe in a rebound until the S&P gets back toward 2000 or so.

Former leaders healthcare and financial stocks are faltering, the CBOE Volatility Index (^VIX) is too high to suggest an all clear, and we could have undergone regime change to bear-market rules.

It’s fair to wonder, though, exactly where the S&P 500 might be trading once such an all clear is sounded. The market typically doesn’t wait to hear them before leaving a trading bottom in its wake.

On a more fundamental level, stock prices are down but stocks aren’t really cheap. They’ve declined less than the forecast for expected 2015 corporate profits have in the past year. And junk-bond yields are at 7.3%. This bull market has done its best work with those yields closer to 6%. So credit remains a headwind for stocks to try and rebuild their valuation.

The policy factor is tricky. All the stories we’ve been telling about how this late-summer storm looks – whether like 1998, 2011 or some other trying year – have the same resolution. Central banks stepped into chaotic markets and promised more support.

Of course, the losses were deeper in both those cases before the markets were assured that all would be OK. And we did not then have the Fed looking eagerly to end its long stay at a zero interest rate.

It’s exhausting to think we remain on that cycle, with investors looking for a wink from the Fed to act as if this is another passing test for the bull market.

But like storms, emergency responses are rarely perfect either.

Robert Shiller’s CAPE ratio signals trouble

There has been a steady decline in the valuation of the stock market from both institutional and individual buyers.

This chart shows Shiller’s stock market confidence index, which he compiles by asking investors whether they think the stock market is overvalued, fairly valued, or undervalued.

Shiller explains that what worries him about this chart is that the drop in investor confidence corresponds with an increase in the valuation and overall index level of the market.

Said another way, investors keep buying stocks even though they don’t really think stocks are, on balance, a good deal. It is, then, something closer to fear than optimism that is fueling the rally in stocks.

This is a similar pattern to what happened for years ahead of the popping of the tech bubble, which Shiller nailed when his book Irrational Exuberance was first published right at the bubble’s peak in 2000.

Now, the idea that Shiller thinks 1) the stock market is currently in a bubble and 2) that this bubble is being inflated in part by – or in spite of – our fears is not a new theme for him. About a year ago, Shiller said our anxieties were driving the stock market to new record highs.

And in multiple interviews this year Shiller has said there is a bubble element to what we’re seeing in the stock market while reiterating his call that this stock market rally is a new normal boom that is more or less devoid of optimism about the future.

Beyond the confidence index, Shiller is perhaps best known for his CAPE, or cyclically adjusted price-to-earnings ratio, which measures inflation-adjusted earnings over a 10-year rolling period.

The idea behind this measure is to give investors a longer-term view on whether stock prices are cheap, fairly valued, or expensive relative to history. Shiller recently mentioned that he found this measure substantially predicts stock returns over the next decade.

And right now, the Shiller CAPE ratio makes stocks look pretty expensive, meaning returns will probably be pretty crappy going forward. So at least we have that to look forward to.