economic & stock market outlook - baird financial … · source: ned davis research baird...

2016 Economic & Stock Market Outlook

Strategy for an Uncertain Environment R. W. Baird & Co.

| 1

April 6, 2016

Bruce Bittles

Chief Investment Strategist

(941) 906-2830

[email protected]

Baird Economics and Investment Strategy | 2

Current Outlook

• Three Focus Points

Impact of Fed Tightening

Economic Resiliency

Inflation Surprises

• Headwinds

Excessive Valuations

Investor Illiquidity

Falling Commodity Prices

Excessive Debt

Election-Year Noise

2016 Outlook: Volatility Rising as 2015

Headwinds Linger

Baird Economics and Investment Strategy | 3 Source: Ned Davis Research

A Gradual Path of Tightening Historically

Not Disruptive for Stocks

Fed Missed Its Chance to Raise Rates


© Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.

See NDR Disclaimer at www.ndr.com/copyright.html For data vendor disclaimers refer to www.ndr.com/vendorinfo/

HOT201601151B_C

Crude Oil Futures vs. Commodities Daily Data 1999-03-01 to 2016-01-14 (Log Scale)



HOT201601151B_C

Crude Oil Futures vs. Commodities Daily Data 1999-03-01 to 2016-01-14 (Log Scale)

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

10

11

13

14

16

18

20

22

25

28

32

35

40

45

50

56

63

71

79

89

100

112

126

141

158

178

Crud

e

158

168

178

188

200

211

224

237

251

266

282

299

316

335

355

376

398

422

447

473

501

531

562

596

631

668

708

750

794

CCI

Crude Oil Perpetual Futures

Continuous Commodity Index (CCI)

Source: Commodity Research Bureau, www.crbtrader.com, Commodity Systems, Inc. (CSI) www.csidata.com

Shaded areas represent CCI corrections of 20% or more.

*Correlation of 5-Day returns.

Correlation Coefficient (Since 1999) = 0.66

Correlation Coefficient (Since 1979) = 0.5

2004 2008 2012 2015

Source: Ned Davis Research

Source: Ned Davis Research Baird Economics and Investment Strategy | 5

Wage Growth Acceleration Suggests

Inflation Could Move Higher Labor Markets Strong Wages Begin to Improve for First Time in

Ten Years


Headline growth has been choppy, but growth in domestic demand has been greater than its long-term average in 5 of 6 quarters

Beyond the Headlines, Economic Growth

Steady – Two-Tiered Economy

Real GDP Quarterly Change

Final Sales Quarterly Change

Industrial Production Weakens


(E202)

Monthly Data 1/31/1948 - 12/31/2015 (Log Scale)

Industrial Production When:

Gain/ %

Index Y/Y Change Is: Annum of Time

Above 4.9 5. 8 35. 7

Between -1.6 and 4.9 2. 2 48. 6

* -1.6 and Below -1. 0 15. 7

Shaded areas represent

National Bureau of

Economic Research recessions.

Source: Federal Reserve Board 15

16

18

20

22

25

28

31

35

39

43

48

53

59

66

74

82

92

102

15

16

18

20

22

25

28

31

35

39

43

48

53

59

66

74

82

92

102

Production Contracting

Production Expanding12/31/2015 = -1.8%

-12

-9

-6

-3

0

3

6

9

12

15

18

21

24

27

-12

-9

-6

-3

0

3

6

9

12

15

18

21

24

27

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Industrial Production

Industrial Production (Year-to-Year Change) -- Mode Basis

Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.

. www.ndr.com/vendorinfo/ . For data vendor disclaimers refer to www.ndr.com/copyright.htmlSee NDR Disclaimer at

U.S. Economy

INDUSTRIAL PRODUCTION

Production Expanding

Production Contracting


Service Sector Remains Vibrant

ISM Non-Manufacturing Index


Monthly Data 7/31/1997 - 12/31/2015

(E235)

NMI 12/31/2015 = 55.3

40

44

48

52

56

60

64

40

44

48

52

56

60

64

New Orders 12/31/2015 = 58.2

40

45

50

55

60

65

40

45

50

55

60

65

Business Activity 12/31/2015 = 58.7

40

45

50

55

60

65

70

40

45

50

55

60

65

70

Employment 12/31/2015 = 55.7

Shaded area represents National Bureau

of Economic Research recession 35

40

45

50

55

60

35

40

45

50

55

60

Supplier Deliveries 12/31/2015 = 48.5

UPS

Strike

Source: All data from Haver Analytics 45

50

55

60

65

70

45

50

55

60

65

70

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

ISM Non-Manufacturing Index (NMI) and Its Components



New Orders

Business Activity

Employment

Supplier Delivery


55


U.S. Recession Probability Low

1990 2001 2007 2016

Global Economic Growth Has Slowed and

Manufacturing Is Weak, but Recession Risk in the

U.S. Is Minimal

Headwinds for 2016

1. Valuations Stretched

2. Earnings Growth Decelerating

3. Excess Debt Globally

4. Investor Psychology Conflicting

5. Breadth of Stock Market Narrow



1. Valuations Excessive - Relying on Forward

Earnings Unreliable

(DAVIS107)


Price Move of:

-3.5% to Overvalued (+1SD)

-21.1% to Median Value

-38.7% to Undervalued (-1SD)

NYSE Composite Gain/Annum When:

Gain/ %

Median P/E Is: Annum of Time

* Above 20.5 -0. 8 24. 6

Between 17.5 and 20.5 6. 5 37. 5

17.5 and Below 14. 3 37. 8

1/31/2016 = 9632.71 Source: New York Stock Exchange 712

826

958

1111

1288

1494

1733

2009

2330

2703

3134

3635

4216

4890

5671

6577

7628

8846

10260

712

826

958

1111

1288

1494

1733

2009

2330

2703

3134

3635

4216

4890

5671

6577

7628

8846

10260

1/31/2016 = 23.8

Very Overvalued

Overvalued

Bargains

35.6 Year

Median = 18.7

Me

dia

n+

1 S

D

+2

SD

-1

SD

-2

SD

Source: Ned Davis Research Calculations 7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

NYSE Composite

NYSE Composite Median Price/Earnings Ratio (NDR Calculation)

NYSE Composite

Median P/E Ratio 24X 2007 1998

S&P 500 Price to Sales Ratio




DAVIS208

Standard & Poor's 500 Index Monthly Data 1964-03-31 to 2016-01-31 (Log Scale)



DAVIS208

Standard & Poor's 500 Index Monthly Data 1964-03-31 to 2016-01-31 (Log Scale)

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

79

100

126

158

200

251

316

398

501

631

794

1,000

1,259

1,585

1,995

79

100

126

158

200

251

316

398

501

631

794

1,000

1,259

1,585

1,995

Source: S&P Dow Jones Indices

S&P 500

Gain/Annum When

S&P 500 Median P/S is:% Gain/

Annum

% of

Time

* Above 1.53 -0.24 19.94

Between 0.7 and 1.53 6.60 46.96

Below 0.7 10.22 33.11

S&P 500 Median Price/Sales Ratio

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

Median = 0.90

+1 SD = 1.39

+2 SD = 1.88

-1 SD = 0.41

2016-01-31 = 1.96 Source: S&P Capital IQ Compustat

S&P 500 Index

S&P 500 Median Price/Sales Ratio

2000 2007 2016


Stock Market Capitalization as % of Gross

Domestic Income



(S702A)

8/31/1929 = 85.7%

6/30/1932 = 26.3%

11/30/1936 = 70.7%

4/30/1942 = 18.9%

12/31/1965 = 69.9%

11/30/1968 = 73.8%

1/31/1973 = 77.1%

9/30/1974 = 35.3%

7/31/1982 = 31.4%

10/31/1990 = 42.6%

3/31/2000 = 164.0%

5/31/2007 = 124.8%

2/28/2009 = 58.1%

5/31/2015 = 137.0%

Very Undervalued

Overvalued

Bubble Territory

NDR Estimated value of 4100 U.S. common stocks: $21. 79 trillion

U.S. Gross Domestic Income (latest figure): $17. 94 trillion

Current ratio for 1/31/2016 ( ): 121. 5 %

GDP used prior to December 1946 (NDR Estimates prior to December 1928)

Gross Domestic Income used after December 1946

Calculation uses NDR Estimated Common Stock Market Capitalization of U.S.-based Companies

Dow Jones Total Stock Market Capitalization used from January 1973 through September 1980

NYSE Market Capitalization used prior to January 1973

Sources: S&P Dow Jones Indices, Ned Davis Research,

Bureau of Economic Analysis, Department of Commerce

19

21

23

25

27

30

33

36

39

43

47

51

56

61

67

73

80

87

96

105

114

125

137

149

163

19

21

23

25

27

30

33

36

39

43

47

51

56

61

67

73

80

87

96

105

114

125

137

149

163

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Stock Market Capitalization as a Percentage of Gross Domestic Income



Bubble Territory

70-Year Norm


2. S&P 500 Earnings: Far Worse Than

Advertised - Wall Street Journal

Baird Economics and Investment Strategy | 14 Source: Ned Davis Research

Wall Street Earnings Forecasts




S677

Consensus Estimates for S&P 500 Operating Earnings per Share by Calendar Year

Weekly Data 2011-09-26 to 2016-02-25



S677

Consensus Estimates for S&P 500 Operating Earnings per Share by Calendar Year

Weekly Data 2011-09-26 to 2016-02-25

Nov

2012

Jan Mar May Jul Sep Nov

2013


2014


2015


2016

Jan Mar

97.5

100.0

102.5

105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

130.0

132.5

135.0

137.5

140.0

97.5

100.0

102.5

105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

130.0

132.5

135.0

137.5

140.0

Calendar Year 2012: 03/28/2013 = 96.83

Calendar Year 2013: 03/31/2014 = 107.3

Calendar Year 2014: 03/31/2015 = 113.03

Calendar Year 2015: 02/25/2016 = 100.88

Calendar Year 2016: 02/25/2016 = 119.17

Source: Standard & Poor's

2012

2013

2014 2015

2016


Profit Margins High

Baird Economics and Investment Strategy | 16 Source: NIPA


High Valuations Do Not Always Immediately

Impact Prices, But Over Time, They Depress

Returns

3. Excessive Debt Globally Causing Economic Growth to Stall




DAVIS214B

U.S. Private Domestic Non-Financial Debt as a Percentage of GDP Quarterly Data 1951-12-31 to 2015-09-30



DAVIS214B

U.S. Private Domestic Non-Financial Debt as a Percentage of GDP Quarterly Data 1951-12-31 to 2015-09-30

5.0

7.5

10.0

12.5

15.0

17.5

20.0

22.5

25.0

27.5

30.0

32.5

35.0

37.5

40.0

42.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

22.5

25.0

27.5

30.0

32.5

35.0

37.5

40.0

42.5Nominal GDP 3-Year Rate of Change 2015-09-30 = 11.29%

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

50

53

56

60

63

67

71

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

50

53

56

60

63

67

71

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178 Private Domestic Non-Financial Debt as a Percentage of GDP 2015-09-30 = 147.97%

Source: Department of Commerce, Federal Reserve Board

Nominal GDP

Gain/Annum When

Debt/GDP is:% Gain/

Annum

% of

Time

* Above 131% 3.76 23.13

Between 101% and 131% 5.96 25.49

Below 101% 7.73 51.37

Concept Courtesy: Richard Vague, The Next Economic Disaster

U.S. Economy

Private Domestic Non-Financial Debt

1960 1980 2000 2015


Canadian Debt Trouble




DAVIS214I

Canada Private Domestic Non-Financial Debt as a Percentage of GDP Quarterly Data 1961-12-31 to 2015-06-30



DAVIS214I

Canada Private Domestic Non-Financial Debt as a Percentage of GDP Quarterly Data 1961-12-31 to 2015-06-30

10

15

20

25

30

35

40

45

50

55

60

10

15

20

25

30

35

40

45

50

55

60Nominal GDP 3-Year Rate of Change 2015-06-30 = 10.03%

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188

200

211

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188

200


Source: Haver Analytics, Private Debt Source: Bank for International

Settlements, Long series on credit to the private non-financial sector

Nominal GDP

Gain/Annum When

Debt/GDP is:% Gain/

Annum

% of

Time

* Above 156% 3.91 18.68

Between 112% and 156% 6.48 44.87

Below 112% 10.62 36.45


Canada GDP

Private Domestic Non-Financial Debt % of GDP

1980 2000 2015


China’s Debt Explosion




DAVIS214G

China Private Domestic Non-Financial Debt as a Percentage of GDPQuarterly Data 1992-12-31 to 2015-06-30



DAVIS214G

China Private Domestic Non-Financial Debt as a Percentage of GDPQuarterly Data 1992-12-31 to 2015-06-30

30

40

50

60

70

80

90

100

110

120

130

30

40

50

60

70

80

90

100

110

120

130 Nominal GDP 3-Year Rate of Change 2015-06-30 = 28.90%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188

200

211

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188

200


Source: Haver Analytics, Private Debt Source: Bank for International

Settlements, Long series on credit to the private non-financial sector

Nominal GDP

Gain/Annum When

Debt/GDP is:% Gain/

Annum

% of

Time

* Above 131% 12.61 27.78

Between 111% and 131% 15.25 34.43

Below 111% 17.24 37.79


China GDP 3-year Rate of Change

China’s Private Domestic Non-Financial Debt % of GDP


Margin Debt Hits Record High in 2015


(S0420)


S&P 500 Index Gain Per Annum When:

(5/31/1948 - 12/31/2015)

Margin Debt to Gain/ %

GDP (%): Annum of Time

Above Avg. 10. 7 58. 7

* Below Avg. 2. 8 41. 3

Source: S&P Dow Jones Indices 16

21

28

36

47

61

79

103

134

174

226

294

382

497

646

840

1092

1419

1844

16

21

28

36

47

61

79

103

134

174

226

294

382

497

646

840

1092

1419

1844

15-Month Smoothing

( )

Margin Debt = $461.20 Billion ______________________

GDP = $18148.40 Billion

= 2.54%

0.15

0.17

0.20

0.24

0.28

0.33

0.39

0.45

0.53

0.62

0.73

0.86

1.00

1.18

1.38

1.62

1.90

2.23

2.61

0.15

0.17

0.20

0.24

0.28

0.33

0.39

0.45

0.53

0.62

0.73

0.86

1.00

1.18

1.38

1.62

1.90

2.23

2.61

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Standard and Poor's 500 Index

Margin Debt as a Percentage of GDP



S&P 500 INDEX

MARGIN DEBT

2000 2007 2016


4. Investor Sentiment – Excessive Pessimism AAII Investor Survey


S&P 500 Index

Excessive Optimism

Excessive Pessimism


5. Market Breadth Problematic


S&P 500 Index

S&P Industry Groups

22%

92%



Historical Seasonal Pattern for S&P 500 in

2016 A Road Map – Best Opportunities Following Election

October


Fundamental Factors

• Federal Reserve Policy Neutral 0

• Economic Fundamentals Bullish +1

• Valuations Bearish -1

Technical Factors

• Investor Sentiment Neutral 0

• Seasonal Influences Bullish +1

• Tape Bearish -1

Weight of the Evidence = Neutral

Our approach balances what could be versus what is.

It is more about managing risk than making forecasts.

Forget about the headlines and tune out the noise.


Bottom Line (And What To Do About It)

• Intro to volatility in 2015 expected be followed by increase in

volatility in 2016.

• Fed tightening is not an impediment, but inflation could be

wildcard. Economic growth uncertain but no recession expected

• Excessive valuations and elevated equity exposure remain key

headwinds.

• Presidential election years tend to be noisy and 2016 looks to

be no different. Ear plugs may be useful.


What To Do About It:

• Trends continue to favor U.S. leadership, prospects in Europe

improving but global markets remain unstable – 80% allocation to

U.S. recommended

• Large-cap issues typically outperform in uncertain environment

• Sector leadership expected to be in defensive areas including

Utilities, Telecom and Consumer Staples – Industrial Sector

Improving

• In periods of volatility and illiquidity, cash is a scarce resource.

Recommend 15% to 20% cash allocation

Baird Economics and Investment Strategy /

Contact Information Bruce Bittles

Chief Investment Strategist

Robert W. Baird & Co., Inc.

(941) 906-2830

[email protected]

mailto:[email protected]


Appendix - Important Disclosures This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy.

ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST

The indices used in this report to measure and report performance of various sectors of the market are unmanaged and direct investment in indices is not available.

Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United States Securities and Exchange Commission, FINRA, and various other self-regulatory organizations and those laws and regulations may differ from Australian laws. This report has been prepared in accordance with the laws and regulations governing United States broker-dealers and not Australian laws.

Copyright 2016 Robert W. Baird & Co. Incorporated

Other Disclosures

United Kingdom (“UK”) disclosure requirements for the purpose of distributing this research into the UK and other countries for which Robert W. Baird Limited (“RWBL”) holds a MiFID passport.

This material is distributed in the UK and the European Economic Area (“EEA”) by RWBL, which has an office at Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB and is authorized and regulated by the Financial Conduct Authority (“FCA”).

For the purposes of the FCA requirements, this investment research report is classified as investment research and is objective.

This material is only directed at and is only made available to persons in the EEA who would satisfy the criteria of being "Professional" investors under MiFID and to persons in the UK falling within articles 19, 38, 47, and 49 of the Financial Services and Markets Act of 2000 (Financial Promotion) Order 2005 (all such persons being referred to as “relevant persons”). Accordingly, this document is intended only for persons regarded as investment professionals (or equivalent) and is not to be distributed to or passed onto any other person (such as persons who would be classified as Retail clients under MiFID).


Robert W. Baird & Co. Incorporated and RWBL have in place organizational and administrative arrangements for the disclosure and avoidance of conflicts of interest with respect to research recommendations.

This material is not intended for persons in jurisdictions where the distribution or publication of this research report is not permitted under the applicable laws or regulations of such jurisdiction.

Investment involves risk. The price of securities may fluctuate and past performance is not indicative of future results. Any recommendation contained in the research report does not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. You are advised to exercise caution in relation to the research report. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice.

RWBL is exempt from the requirement to hold an Australian financial services license. RWBL is regulated by the FCA under UK laws, which may differ from Australian laws. This document has been prepared in accordance with FCA requirements and not Australian laws.

economic & stock market outlook - baird financial … · source: ned davis research baird...

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