Down Under Daily, 22 December 2014

5 Charts For 2015

Here are five charts Ill be watching in 2015: Exhibit 2
Where Are The Earnings?
Exhibit 1 DEVELOPED MARKET MSCI CONSENSUS EPS FORECASTS

Settling The Debate About Capacity 36

BASED ON IBES CONSENSUS ESTIMATES
36

US WAGES & BUSINESS PAY EXPECTATIONS 2010

5.0 25 34 2016 34

4.5 2014
20 32 2013 2015 32
4.0
2009
3.5

NET BALANCE
15
30 30
12M%

3.0
2.5 10 2012
2.0 28 28
5
1.5 2008

US$ PER SHARE

1.0 WAGES* NFIB PAY (RHS) 26 26
0 2011
0.5 * WAGE & SALARIES FOR CIVILIAN WORKERS % OF COMPANIES
PLANNING TO INCREASE COMPENSATION LEAD BY 9M. 3M AVERAGE
0.0 -5 24 24
1986 1990 1994 1998 2002 2006 2010 2014 2007

Source: BLS, NFIB, NBER; Minack Advisors 22 22

2006 2010
The Fed is the only major central bank likely to 20 20

tighten monetary policy next year. How soon it

18 2005 18
12M FORWARD EPS
tightens will likely depend on how near full capacity
the US is operating. Headline inflation will not be a 16 16

good guide: falling oil prices point to very low 2004 2009
14 14
inflation in coming months. My old colleagues at
Morgan Stanley think that if energy prices follow 12 12
2003 2005 2007 2009 2011 2013 2015
current futures pricing then annual headline
Source: MSCI, IBES/DataStream, NBER; Minack Advisors
inflation could turn negative in early 2015.
QE was over-rated, in my view. But interest rates
The Fed has suggested it will look through low matter. US QE did signal that US rates would stay
inflation. This would be more likely if wages low while ever QE was in place. But rates are
growth starts to increase. Rising wages is key already so low outside the US that QE by the ECB or
evidence that the US is nearing full employment. Bank of Japan there will have little additional
Exhibit 1 suggests that that is likely next year. signalling effect in my view.

Exhibit 2 shows consensus EPS forecasts for MSCI Exhibit 3

developed equity markets. Analysts are cutting Monetary Policy Is Tightening
2015 and 2016 EPS forecasts. To be fair, part of this DEVELOPED MARKET LIQUIDITY & YIELD CURVE
15 4.0
is due to US$ strength. But earnings outside the US * NARROW OECD MONEY SUPPLY (EX HIGH-INFLATION
COUNTRIES) LESS GDP GLOBAL 10YR RATES LESS 1-3YR
12 RATES. 3.5
have been poor over the past four years. Forecast EXCESS MONEY* (LHS)
3.0
9 YIELD CURVE
EPS is no higher now than in 2012, or 2008. 2.5
12M%

6
%

2.0
Weak earnings didnt seem to matter through the 3
1.5
2012-13 valuation re-rating. But I think the re- 0
1.0

rating story is over. Without better earnings -3 0.5

growth it could be another anaemic return year for -6 0.0

1984 1988 1992 1996 2000 2004 2008 2012 2016
developed world equity investors. DM equities are
Source: OECD, Citibank, NBER; Minack Advisors
up less than 3% year to date. Worse, developed
markets have fallen by 7% excluding the US. Put another way, QE in Europe and Japan will not
Better growth does seem in prospect; that is now a offset the prospect of tighter US policy. Rate
necessity to expect positive returns in 2015. markets are starting to reflect that change.

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Monday, 22 December 2014
Developed economies yield curves are flattening. Finally, credit markets could again be the early
Exhibit 3 shows that flatter curves tend to go hand- warning sign in this cycle, as they were in the last.
in-hand with lower excess money supply growth Zero rates have arguably created more mis-priced
(money supply growth above nominal GDP). Equity risk in debt markets than equity markets. A shift in
valuations also tend to de-rate when the curve bear monetary policy therefore could be felt first in
flattens (flattens because of rising short rates). credit than in equities.

Everyones a dollar bull, it seems. Exhibit 4 shows
that sustained dollar rallies have gone hand-in-hand
with rising US terms of trade (ratio of export prices
to import prices). This makes sense: rising terms of
trade signals that a country can cope with sustained
currency appreciation. (Of course, the reverse is
also true, as Australia is now experiencing.)
Exhibit 4
Extended US$ Strength Due To Terms Of Trade
US TERMS OF TRADE AND US$
115
* EXPORT PRICES/IMPORT PRICES REAL BROAD TWI
TERMS OF TRADE* US$ TWI (RHS)
110
INDEX (ToT)
This year already saw a narrowing in asset returns.
Exhibit 5 shows the recent, widening divergence
between US equity valuation and performance of
high yield credit. My base case is that US equity
valuations will fall through 2015, following the lead
from the de-rating in other risky asset markets.
However, I am alert to the risk that investors funnel
into Wall Street, and US equities see a final
valuation surge. Exhibit 5 is a warning that the
correlation between equities and credit can break,
135 at least for a time that matters to many investors.
120 Exhibit 5
Credit Could Lead, Again

INDEX (TWI)

105 105
S&P500 PROSPECTIVE PE & HIGH YIELD SPREAD
17 2
100 90 16 S&P 500 PE (LHS) 3

OAS SPREAD % [INVERTED]

15 4
95 75 14 5
ALL-TIME LOW (FROM 1927)
PE RATIO

13 6
90 60 12 HIGH YIELD OAS 7
1982 1986 1990 1994 1998 2002 2006 2010 2014 SPREAD
11 [INVERTED] (RHS) 8
Source: BEA, Federal Reserve, NBER; Minack Advisors
10 9
AVERAGE SPX PE FROM
9 1985 EX 1998-2006 10
But Exhibit 4 is also important because if the dollar 8 11

keeps rallying without supporting terms of trade

WHATEVER IT TAKES
7 12
2008 2009 2010 2011 2012 2013 2014 2015 2016
improvement it is a signal that financial forces are Source: S&P, IBES/DataStream, Barclays, NBER; Minack Advisors
at work. One likely force is stress on foreigners who
have borrowed dollars over the past five years. Put Have a great (and safe) break. As usual, thanks for
another way, a rising US$ unsupported by the terms the bouquets and brickbats through the year at
of trade is a bearish augur. least I know youre reading. Cheers, Gerard

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Monday, 22 December 2014
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Monday, 22 December 2014