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Equities:Andthentherewerenine
JohnAuthers

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Apartfromafewstocks,theUSmarketsareinaslumpwithfearspost
crisisrallyhasrunitscourse

FT

UScompanieswithFangs:Facebook,Amazon,NetflixandGoogle

aditnotbeenforasmallgroupofniftycompanies,2015wouldhaveenteredthehistory
booksasaterribleyearfortheUSstockmarket.Asitwas,stockswerealmostexactlyflat,
aswerebondsandcash,meaningthatUSbondsandequitieshadtheirsecondworstcollective
12monthssince1995outstrippedonlybythedisasteryearof2008.
Itstheworldoflownumbers,saysAndrewMilligan,chiefinvestmentstrategistatStandard
LifeinEdinburgh.
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Yetthereweresomeveryhighnumbersforagroupoffour
companiesthathavecometobeknownastheFangsFacebook,Amazon,Netflixand
GoogleandforaslightlywidergroupthataddedMicrosoft,Salesforce,eBay,Starbucksand
PricelinetocreatetheNiftyNine.Bothgroupsgainedmorethan60percentfortheyear.
Awayfromtheexcitementgeneratedbythesehotcompanies,thingsweredire.TheS&P500
equalweightedindex,whereeachofthe500companiesreceives0.2percentoftheindex,was
down,andunderperformedtheS&Pweightedbymarketcapitalisation.
Suchanarrowingofthemarketisaclassicsymptomofalengthyrallythisonehaslasted
almostuninterruptedsince2009thatiscomingtoanend.Investorsrunoutofideasand
insteadpourmoneyintoafewcompanieswithapositivestorytotell.Theunderperformanceof
smallercompaniesisasignthatinvestorsaregrowingmorecautious.
ThedominanceoftheNiftyNinerecallsthelate1960sandearly1970s,whenalongbull
marketpeteredoutintoaperioddominatedbyaNiftyFiftyofcompaniessuchasXerox.
Technicallythisfeelsverybearish,saysJimPaulsen,chiefstrategistatWellsCapital
Management.TheclosestfeelistheNiftyFiftyerawhenmuchofthemarketpeakedinthelate
60sbuttheNiftiescarriedonuntil1972.
HesaidtheperformanceofAmazon,whichisrevolutionisingconsumerindustries,is
particularlydistorting,andthatofthewiderconsumerdiscretionarysectorwhichwasthe
bestperformingsectorof2015hadanightanddaydifferencewithoutit.
Partofthereasonisthatprofitsareindecline,mainlyduetotheproblemsfallingoilprices
havecreatedforenergycompanies.Weshouldntbesurprised,becausetheresaprofits
recession,andinprofitsrecessionsmarketsbecomeveryDarwinist,saysRichardBernstein,
aninvestmentconsultant.ThatDarwinismmeansthatmoneyflockstothecompaniesthatcan
showstrongrevenuegrowth,suchasNetflixwhoseprofitshalvedinthethirdquarterbut
continuestoshowsubscribergrowthorAmazon.Bothsawtheirsharepricesmorethan
double,asfundsfloodedoutofcompaniesperceivedtobelosingouttothemandregistering
disappointingprofits,suchasViacomandothermainstreamtelevisionmediagroupsor
Walmartandotherretailers.
AccordingtoPeterAtwaterofFinancialInsyghts,whoanalysesmarketpsychology,narrow
participationisasymptomofextremenerves,aslastseenduringthe1990sinternetbubble.
WritingbeforetheUSFederalReservedecidedtoraiserateslastmonth,hepointedoutthatfor
2015,thetop10stocksintheS&P500areup13.9percentwhiletheother490aredown5.8
percentthelargestspreadsincethelate1990s!
Ithasalsogrownmoreimportanttopickwinners,whilethereareplentyofloserstochoose
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from.ThomasLeeofFundstratsaysthathehadseenFanglikeconcentrationsinthepast,but
usuallythetopandbottom10canceleachotherout.In2015,thewinnersfaroutperformedthe
losers.
MrLeewarnedthatFanglikelyendswithaDang!astopmoversinoneyearhaveastrong
tendencytounderperforminthenext.
Valuationtrendssuggestthatthenextmoveismorelikelytobedownwards.USstocksendured
acorrectionduring2015,droppingmorethan10percentinAugustastheChinesecurrency
revaluationsenttremorsthroughthefinancialworld.But,toquoteMrPaulsen,itwasnota
pausethatrefreshes.
Wedidnotresetvaluationsorrefreshtheprofitcycle,hesays.Instead,theS&P500had
almostregaineditshighsbytheendofOctober,andUSshareprices,judgedbyamultipleof
earnings,endedtheyearasexpensiveastheybeganit.
Tellingindicators
Thetwocriticalmeasuresthatshouldsetthemarketsdirectionareearningsandinterestrates.
Inthethirdquarter,S&P500earningsdroppedby0.8percentyearonyear,andthe
consensusexpectationisthattheywillbedown3.5percentinthefourthquarter,mostly
thankstoenergy.Meanwhile,Europemayhavehitthebottomofitsownprofitsrecession,with
earningsfortheStoxx600companiesfalling5.1percentyearonyearinthethirdquarter.
Therenewedfallintheoilpricehasraisedconcernsthatenergycompanieswillbeforcedto
writedownthevalueoftheassetsmoresharply.Oncethisdamageisdone,hopesonWall
Streetarehighforareboundfromalowbasebrokersanalystsnowforecast7.9percent
earningsgrowthfortheS&P500asawholein2016.However,equitystrategistsandasset
allocators,whotakeamoretopdownview,expectthesenumberstobemarkeddown
considerablyastheyearcontinues.Further,earningstendtomoveincycles,andintheUSthe
cycleappearstohaveturned.
Asforrates,theFedhastoldmarketstobraceforfourmoreraterisesthisyear,whiletheFed
fundsfuturesmarketisimplicitlyonlypricingintwo.Allelseequal,lowerrateswouldaid
shareprices.Butallelseisnotequal.LowerrateswouldimplyasicklyUSeconomy,which
wouldhithopesforearnings.
SothegreathopethatanarrowUSmarketwillnottipoverintoabearmarketthisyearisthe
USeconomy.Therearefewsignsofarecessionandwithoutarecession,equitybearmarkets
areusuallynotsevere.Indeed,outsideofmanufacturing,whichisinaglobaldownturn,the
economylooksrobust.ThehopeisthatserviceswillstarttobenefitasUSconsumersatlast
begintospendthemoneytheyhavesavedonoil.
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Profitmarginsarenotgoinganyhigher,andratesarentgoinganylower,andtheresalotof
thingsusedup,saysMrPaulsen,whosebestguessisthatanotherflatyearisintheoffing.
Butitshardtoseearecession.

Excitementaroundafewbigneweconomystockswasintenseduring2015.Netflixand
Amazonbothmorethandoubled,whileFacebookandtheGooglecompaniesalsoenjoyeda
greatyear.Putthesestocks(knownastheFangsfortheirinitials)togetherwithEbay,
Priceline,Salesforce,MicrosoftandStarbucks,tocreateaNiftyNineandtheybeattherestof
theUSmarketbymorethan60percent.

Thatisworrying.Dominancebyafewbigcompaniesoranarrowingmarketisa
symptomoftheendofabullrun,asitwasintheearly1970s(dominatedbytheNiftyFifty)
orthelate1990s(dominatedbythedotcoms).Thebiggest50companiesroselastyear,butthe
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Russell2000indexofsmallercompaniesfell,showingconcernsabouttheeconomy,whilean
equalweightedversionoftheS&Palsofell.Moststocksweredown,andinterestisrestrictedto
afew.

S&P500companiessawearningsdeclineslightlyin2015.Thiswasinlargepartduetofalling
revenuesatenergycompanies,drivenbyfallingoilprices.Butthestrongdollar,whichhit
overseasearnings,wasafactor.Sowasdecliningmargins,aswagesstartedaslightrecovery.
Bothearningsandmarginstendtobycyclical,implyingbothcouldhavefurthertofall.
Meanwhile,earningsinEuropefellbyevenmore,raisinghopesthatEuropeancompanieshave
reachedthebottomoftheprofitscycle.

Valuingstocksisandwillalwaysremainanimprecisescience.ManyWallStreetanalystsnow
maketechnicalcriticismsofProfRobertShillerscyclicallyadjustedprice/earningsmultiple,
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whichcomparestopricestoaverageearningsoverthepreviousdecade.Butasimplemultiple
oftheprevioustwelvemonthsearnings,whichismuchnoisierandleapttoextremesduring
theearningsrecessionof2009wheninvestorsuniversallyassumedthatearningswould
recover,givesasimilarconclusion.Pricesarenotextreme,butclearlylookexpensiveby
historicalstandards.

TheUSstockmarkethasvastlyoutperformedtherestoftheworld(includingbothdeveloped
andemergingmarkets)sincethe2008crisis.Lenientmonetarypolicyhelpedthis,asdidthe
strengthoftheUSeconomy,whilethestrongdollaramplifiedtheoutperformance.Butthe
strongdollarshouldhitUScompaniesoverseasearnings,whilestrengtheningtherestofthe
world,andothercentralbanksarenowaggressivelyeasingmonetarypolicywhiletheUS
FederalReservehasjuststartedtoraiserates.

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2015wasdominatedbyspeculationoverwhentheFedwouldraiserates.Thereiseveryreason
toexpectthistocontinue.ThischartshowsthedotsissuedbytheFed,inwhicheachdot
representsthepredictionofadifferentFedgovernorforwheretargetrateswillbeattheendof
2016.Themedianforecastisforfourrisesof0.25percentagepoints.Themarketexpectation,
derivedfromtheFedFundsfuturesmarket,isfortworises.Thisgapwillhavetobereconciled
during2016.
ThisarticlewasupdatedonJanuary4tocorrectyearlyreferencesintheinformationonthe
firstchart,andontheXaxisofthefourthchart
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