By Amy Domini, founder of Domini Social Investments and partner in The Sustainability Group
What’s next? What do you see the markets doing next year, and why? It is a question that those of us who work on Wall Street are used to, yet hate to answer. 2016 is about to unfold, coming on the heels of a fantastic rally in markets that began in 2009 (which means it has gone on a long time) and bringing with it a presidential election. An election brings uncertainty. What is the careful investor to do?
I am one that believes that at the end of the day, stock prices are a reflection of two things, 1) the company’s earnings and potential and 2) the investor’s boldness or fear. Since I believe the economy is poised to create greater corporate earnings, and since I believe the investor is ready to be bold, I am reasonably optimistic about the year ahead. I hedge my bet by reminding the reader that one year is a short horizon, and a disaster of any sort might delay the benefits of the trends I will point to.
However, this year does come within a context, and that context is the long-running recovery of the United States, and seemingly a few other nations, from the financial crisis that is still underway. And a growing economy is good for corporate earnings.
Roughly 70 percent of the U.S. economy is tied to consumer spending. Consumer spending increases are tied to there being more consumers. Making more consumers is done in two ways. First, create more people by growing the size of the population and you have more consumers. The millennium generation is the largest since the baby boom and is hitting their earning years. Further, our nation’s relative openness to immigrants helps create the extra spending. The second way is to get money into the hands of people who don’t have enough to make random discretionary purchases. During 2014 it was estimated that 60 percent of bankruptcies resulted from health care costs, and that medical bills were the leading cause of personal bankruptcy. The Affordable Care Act has removed one very large source of non-consumers, but there are other trends that also give us hope here.
Unemployment claims are made public monthly and currently show that we have very few new people seeking assistance. In fact, new claims are at or near their lowest levels for twenty-five years. While the initial unemployment claims were over 650,000 during the financial crisis, they are under 270,000 now. The average over the period was approximately 374,000, which indicates we are generating new jobs at a good clip.
Another simple indication that gives me reason to hope for continued economic expansion is the growing, but still below average, level of housing starts. Homebuilding is generally an excellent indicator of future growth. People who purchase homes furnish them, sometimes even to the point of borrowing to do so. This extra source of consumption is likely to remain relatively robust for several years to come. After all, average housing starts for the past 50 years have averaged 1.445 million. Currently housing starts are under 1.25 million, coming off a low during the crisis of roughly 500,000.
Finally I look at the federal deficit, which is now over $18 trillion. A large deficit can rob the federal government of the ability to spend, which in turn means that the economy loses an important customer. When federal deficits are very high, the U.S. must pay more to borrow. Money that could be spent building bridges, schools, and other infrastructure that would spur economic growth is ‘wasted’ paying higher interest rates. This is not our problem now. The federal deficit is about 2.5 percent of GDP and at that level, government has no problem borrowing at low rates.
There are those who argue that inflation will pick up, that the jobs are bad jobs, that the best is behind us, but these are conjecture. I am a lot more comfortable looking at the current facts and these are positive.
Still, this does not mean that the investor is positive. To check the mood of the investor, I look at stock prices. With the current forward price to earnings ratio of the Standard & Poor’s 500 standing at 16.13 and with the average since 1985 at 14.94, I am comfortable that the investor is still more optimistic than pessimistic about the future. We were at about this rate during mid-1997, just before an explosion on the upside that lasted for the next two and a half years.
Finally, consider the logic of the scenario. Where is an investor to go? Bonds pay nothing and most of the fancy instruments that might raise returns, like venture capital or private debt, require high minimums and a long-term wait. They just do not suit most investors and are by no means a sure bet anyway. To my way of thinking the investors are comfortable enough to stay.
Ah, but what about the elections? A president is up for vote; a third of the Senate along with every member of the House will hit the airwaves with messages. Local elections will create further noise. During an election a great deal of Bad News is released, particularly about what a crummy job other people are doing. The summer before the national election is a particularly dreary period.
It will be vitally important that a Democrat keep the Presidency. The future of the Supreme Court will be in the next President’s hands. And the acceptance of each new justice will be in the hands of the Senate, which must regain a majority if it is to allow for a Supreme Court that stands with the people, rather than with power. The House is unlikely to shift, so almost no legislation will pass, but appointments should be able to go through. The Executive branch will be able to carry on work, like the recent reduction of jail sentences for non-violent crimes, without Congress.
As I write, the Smart People anticipate a Hillary Clinton versus Marco Rubio election. If so, Florida may well go to Mr. Rubio, and that would make a victory for Mrs. Clinton a great deal harder to reach. Since my assignment was to make predictions about the markets, and not the election, I’ll shy away from attempting to determine whether I agree with the Smart People. But I will say that elections affect markets.
In general, Democrats believe in government and will encourage government spending on domestic programs. This pumps money into the economy. It creates wealthier consumers at the lower income level, exactly where, economically speaking, we need help. Government itself can be a robust new spender, as we saw with the American Recovery Act of 2009, commonly called the Stimulus Package. Around the globe nations were knocked flat by the financial crisis, but with robust government spending, America came through.
I said at the beginning that I am comfortable with predicting a gentle increase in stock prices next year. Longer term, however, I predict that the next election will create the market that follows. Will it be a government that believes in creating consumers or will it be a government that relies on the corporate world to dictate what is good for the economy? If it is the latter, this long-term rally has an end in sight.
Article by Amy Domini, partner in The Sustainability Group in Boston where she manages roughly $1.1 billion in liquid assets for high net worth families. Additionally she is the founder of Domini Social Investments (www.domini.com), a New York City based mutual fund family with $1.6 billion under management. She is widely recognized as the leading voice for socially responsible investing. In 2005 she was named to the Time magazine 100 list of the world’s most influential people, and in 2009 Time listed her as one of 25 “Responsibility Pioneers”. In 2005, President Clinton honored her at the inaugural meeting of the Clinton Global Initiative.
Ms. Domini co-authored the groundbreaking book, Ethical Investing in 1984. Since then she has authored or co-authored several books. Her articles have been widely published and she is a regular contributor to The Intelligent Optimist magazine. Ms. Domini serves or has served on several boards and holds the Chartered Financial Analyst designation.
Ms. Domini holds a B.A. in international and comparative studies from Boston University. She is the recipient of two honorary degrees: a Doctor of Business Administration, from Northeastern University College of Law and a Doctor of Humane Letters by the Berkeley Divinity School at Yale.
