Allen Sinai, PhD
Allen Sinai, PhD, CEO and chief global economist at Decision Economics, Inc., a financial advisory firm based in Boston and New York City. He has been an adviser to several US presidential administrations. DecisionEconomicsInc.com
The current six-year-old bull market can become a 10-year bull market. That’s top economist Allen Sinai’s optimistic prediction for the stock market. Granted, he expects hiccups along the way, especially when the Federal Reserve starts raising interest rates, as it is expected to do later this year for the first time since 2006. But stocks can keep rising for another four years, thanks to an economy that should continue to grow at a moderate pace, Sinai predicts.
Here’s what Sinai forecasts for the economy and the markets for the rest of this year and beyond—and how it will affect you and your investments…
Many investors fear that when the Fed starts to raise interest rates, it will hurt the stock market dramatically. That’s because higher interest rates mean bigger borrowing costs for companies and consumers and more attractive yields on nonstock alternatives such as bonds. The Fed’s policy of keeping short-term rates near 0% has helped stock prices triple since early 2009. But a slow shift to higher rates will not doom the bull market. It will mean that the Fed believes the economy is healthy enough to withstand higher borrowing costs…that the drop in unemployment is increasing consumer buying power…and that companies are regaining the ability to raise prices significantly.
History bears this out. There have been 14 periods during which the Fed boosted short-term interest rates since the Standard & Poor’s 500 stock index was launched in 1957. The average annual return for the index during these periods was 9.6%. The highest returns have tended to come when rates have risen gradually from low levels during periods of negligible inflation, much like conditions today.
Investors typically do not have to worry about the onset of a bear market until one or more of the following harmful events occur. None of the negative events described below is present today or imminent…
The Federal Reserve gets too aggressive. It tightens its monetary policy so severely that high interest rates choke off economic growth. That won’t happen anytime soon because inflation will continue to be benign, which should allow the Fed to take a measured and gradual approach to raising rates. I expect an increase of one-quarter percentage point in September…another one-quarter percentage point in December…and an additional one percentage point spread out through 2016.
Stock prices reach bubblelike proportions, then collapse when corporate earnings can’t live up to expectations. Although the S&P 500 was recently at record highs, its average price was just 18.25 times estimated earnings for the 12 months through May 31, 2016. That’s not cheap, but it is within a normal valuation range historically.
Economic growth deteriorates, leading to a recession. I would put the chances of a recession at less than 1% now. The inordinately long, slow economic recovery and expansion since the Great Recession of 2007–2009 means that we’re only at the midpoint now. The US economy is well-positioned to deliver several more years of reasonable growth paced by strong consumer spending, increased spending by businesses and a stronger global economic upturn.
Inflation soars. Soaring prices reduce the purchasing power of consumers (which in turn cuts into corporate revenue) and lead to higher interest rates (which can weaken the economic expansion). But inflation likely will remain moderate for years, thanks to an extended period of low oil prices and a strong US dollar, which makes imports cheaper.
I would not be surprised to see a sharp stock market correction of 10% or more this fall around the time of the Fed’s first interest rate hike. But investors should not panic and instead should consider it a buying opportunity. I expect that by the end of 2015, both the S&P 500 and the Dow Jones Industrial Average should return 11%, including reinvested dividends.
The back end of this bull market is likely to be somewhat weaker than the period from 2009 through 2014, which saw robust gains averaging 23% annually.
Companies can no longer rely as they have before on cost cutting and cheap borrowing to help drive profits and stock prices. For stock prices to have greater than single-digit gains in the next few years, companies will need to increase revenue faster than they have been lately, and US gross domestic product (GDP) will have to rise by well over 3% each year, compared with 2.4% in 2014.
As for specific stock sectors, while the overall stock market has set record highs recently, financial services companies, including banks, have regained just half of what they lost during the bear market of 2007–2009. Their stocks represent particularly good value today, on average, because rising interest rates will mean improved profit margins. The financial institutions will be able to increase their lending rates and widen the spread between those rates and the rates they pay on deposits.
For even better stock market returns than in the US, investors should look to other parts of the developed world, such as Europe and Japan, where increased economic stimulus measures, including central bank bond-buying programs, are triggering new bull markets.
Here’s what I expect…
GDP: US economic growth prospects remain strong, even though the economy shrank by 0.7% in the first quarter of 2015. That was due to harsh winter weather and a stronger dollar, which tempers inflation but also reduces demand for US exports and hurts revenue and profits at US multinational companies. I consider the anemic first quarter an anomaly. The economy should bounce back as consumer spending strengthens. Also, healthier economies in Japan and the eurozone will help US multinationals. I’m forecasting GDP growth of 2.5% in 2015 and 3% in 2016.
Unemployment: The US should continue to add 200,000 to 250,000 jobs a month, pushing down the unemployment rate to 4.8% by the end of 2015, compared with the recent 5.4%.
Inflation: With energy prices still low, the Consumer Price Index (CPI) will be up just 0.2% for 2015, far below the Fed’s target of 2%.
With interest rates about to start heading upward, which will continue for many years to come, investors need to prepare themselves for an extended bear market in bonds. That means the only returns you can expect from bonds are their yields, with little capital appreciation. I forecast the total return for the bond market to be slightly negative this year. The yield on 10-year Treasuries, which was 2.12% at the end of May, is likely to rise to near 2.75% by year-end.
