More upside seen for stocks in 2015
Stocks can keep climbing next year, tacking even more gains onto their phenomenal run of the last five-plus years. Just don't expect them to be as big — or to come with as little heartburn — as before.
That's what mutual fund managers of all types are forecasting, as they peer ahead to 2015 and coming years. For a hint of what it may be like, just look back a few weeks when the Standard & Poor's 500 index declined more than 7 percent from mid-September through mid-October. The tumble raised investor anxiety, but a stream of strong earnings reports helped it dissipate. The S&P 500 has since climbed to another record high.
Here's a look at the expectations of fund managers for 2015:
Stocks can rise even more
The economy is growing, and employers have added more than 200,000 jobs for nine straight months, the longest such streak since 1995. "Everything is pointing to companies making more money going forward," says Neil Hennessy, chief investment officer of Hennessy Funds, which manages $5.7 billion in assets.
That's key because stock prices, at their heart, are a function of how much profit a company makes and how much investors will pay for it.
The stronger job market means consumers will have more money to spend, as will lower gasoline bills, now that the price of crude oil is close to a four-year low. The hope is that companies will generate more revenue as a result. That's important because, since the recession, corporate profits have grown largely as a result of cutting expenses.
Companies are squeezing more profit from each $1 in revenue than ever before: nearly 10 cents, up from an average of 6.5 cents over the last 20 years, according to S&P Dow Jones Indices. That means any increase in sales will quickly boost earnings.
Don't expect smooth gains
Few fund managers argue that stock prices are cheap, at least relative to their earnings. Instead, they debate whether stocks are just a little more expensive than normal or a lot more.
The S&P 500 has more than tripled since hitting bottom in early 2009, rising faster than corporate profits. Stocks in the index are trading at nearly 17 times their earnings per share over the last 12 months. In early 2009, the index's price-earnings ratio was just above 8.
And because of their high price tags, fund managers say further gains for stocks will likely have to come from earnings growth. Next year, analysts are broadly calling for a rise of 9.9 percent.
So instead of seeing another 2013, during which the S&P 500 surged 29.6 percent, it may be safer to expect annual gains closer to 5 percent or 6 percent in the next few years, says Bill Stromberg, head of equity for T. Rowe Price.
Investors should also be ready for a bumpier ride, Stromberg says. The market has been largely smooth in recent years, with stimulus from the Federal Reserve a likely cause. But the central bank last month declared an end to its bond-buying program. Many economists also expect the Federal Reserve to raise short-term interest rates next year for the first time since 2006. That could lead to sharper swings in stock prices.
Rising rates not always bad
Interest rate hikes have historically scared investors. They make borrowing more expensive and slow down economic growth. The last time the Federal Reserve began raising rates, in 2004, the S&P 500 lost nearly 7 percent in about six weeks.
But after that initial tumble, the market went on to rise nearly 20 percent by the time the Federal Reserve had finished raising rates in 2006. That's similar to the S&P 500's performance in several other rate-hike campaigns, says Andrew Goldberg, global market strategist with J.P. Morgan Asset Management. Stocks usually fall when the Fed begins hiking, but can reverse course after the market digests the news.
The key is whether interest rates are rising off a low starting point, Goldberg says. If they are, higher rates aren't that much more restrictive for the economy. And rates are very low now.
Look abroad for bargains
Value investors turned off by U.S. stocks can find better bargains abroad. European stocks were recently trading at 13.5 times their expected earnings per share over the next 12 months, for example. Their U.S. counterparts were trading at 16 times, according to index provider MSCI.
Of course, foreign stocks have lower valuations for a reason. Europe is struggling to keep its economy out of a deflationary spiral in which falling prices encourage consumers and businesses to delay purchases, which only pushes prices lower. Japan's economy has fallen back into recession.
Among emerging markets, China's economic growth is slowing. Russia may be the world's only market that could double and still be cheap, says T. Rowe Price's Stromberg. But it carries significant risks: As a major oil exporter, it's hurt by crude's plunging price, and political tensions are high between Moscow and the West.