Equity markets in March reflected an increasingly bearish sentiment among investors With good reason: Both the Nasdaq Composite and S&P 500 fell more than 2 percent.
The current S&P 500 Index’s price-to-earnings ratio of 20 is about 18 percent higher (as of April 6) than its historical average of 14.8, according to my research.
Any weakness in economic data seems to trigger a sell-off these days.
Dollar Backlash
Clearly, the strength of the US dollar has been a problem for the multinational companies.
Nearly 20 percent of S&P 500 companies have issued earnings warnings for the first quarter and some companies have pointed to the impact of the strong dollar on top and bottom line earnings.
These developments have made the stock prices of the US companies less competitive abroad, especially against their European counterparts.
Double Trouble
About 20 percent of the revenue of companies listed on S&P 500 Index are affected by the dollar’s strength.
The appreciation of the dollar is especially problematic for companies with exposure to countries such as Mexico, which is an important trading partner for the US exporters.
According to my research, the impact of the change in the dollar on the S&P 500 tends to lag by quarter.
Based on my analysis of historical data from 1990, I expect that a 10% appreciation of the dollar in the current quarter would cause a 5% reduction in S&P 500 in the next quarter.
Dollar Proof
Companies that provide goods and services to domestic consumers are not expected to be negatively influenced by the strength of the dollar.
A variety a factors shape the outlook for small- and mid-cap companies in the consumer staples and consumer discretionary sectors.
However, in general terms, they are less global and therefore less impacted by currency swings.
As the US economy is more consumer than export-driven, some of the negative impact of the strong currency should be offset by stronger consumer demand in general.
The US Consumer Confidence Index is at its highest level since 2007 and jobs growth is robust, despite a disappointing March employment report.
Solid Economy
Apart from the strong dollar, the US economic growth does not show any worrying signs of weakening.
Given that the unemployment rate came down to the target level, the prospect of the U.S. Federal Reserve increasing the interest rates this year has been causing volatility in the markets.
The move toward higher rates may be slow. However, in my opinion, rising oil prices and inflation expectations will prompt the Fed to move in June.
Bullish on Tech
Going forward, we maintain an optimistic view of the US equity markets despite the fact that some investors are shifting their portfolios in favor of European stocks.
We believe that US companies face the challenge of reaching double digit earnings-per-share growth when the nominal GDP growth is barely around 4%.
Low oil prices and falling inflation have created an environment where expectations of company earnings need to be revised downwards.
We expect the IT sector to outperform in the second quarter of 2015, given the slowly recovering capex spending and the demand for IT.
Photo Credit: Mike via Flickr Creative Commons
