Outlook on the S&P500, Impact of a Strong US Dollar & Fed Interest Rate Decision

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This week…
• Outlook on the S&P500
• Will the Fed hike interest
rates?
• Impact of a strong US
Dollar on the S&P500

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Invast.com.au 1800 468 278
General Advice & Risk Warning
Please note that any advice given by Invast staff is deemed to be GENERAL advice, as the information or advice given
does not take into account your particular objectives, financial situation or needs.
Therefore at all times you should consider the appropriateness of the advice before you act further.
CFDs and Forex are leveraged products and carry a high level of risk and are not suitable for everyone. You can lose
more than your initial deposit so you should ensure CFD and Forex trading meets your investment objectives. We
recommend you seek independent advice. Strategies and charts used in this presentation are for example only. You are
reminded that past performance is not indicative of future performance.
Invast Financial Services is regulated by ASIC. It's important for you to read and consider the relevant Product
Disclosure Statement and Financial Services Guide which contains details of our fees and charges before you decide
whether or not to acquire any financial products. These documents are available at www.invast.com.au
Invast Financial Services Pty Ltd ABN: 48 162 400 035. Australian Financial Services Licence No.438 283

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This week we look at the following topics:
• Outlook on the S&P500
• Will the Fed hike interest rates?
• Impact of a strong US Dollar on the S&P500

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Dear Readers,
Our analysis this year has so far touched on the 2015
broader Outlook Guide and in February we focused on
Australian listed companies. The new push this year is on
individual stocks, powered by Invast’s new DMA platform.
The benefit of this platform is that it provides direct market
access into several global exchanges.
Our focus in March will be to analyse these major exchanges,
as represented by key indices. Indices are important to
understand even if you trade underlying stocks. All of the
indices that we touch on in March are traded through
Invast’s MT4 platform, which remains a powerful trading tool
and part of the overall Invast toolbox for traders.

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In April we plan to focus on individual stocks across these indices and we will group
these stocks into various trading baskets across four individual weeks. But before that
can occur, we need to study and analyse to see where each index is currently trending.
Our analysis will be broken up as follows:
 Week commencing 2 March 2015: Outlook for the German DAX30
 Week commencing 9 March 2015: Outlook for the UK FTSE100
 Week commencing 16 March 2015: Outlook for the US S&P500
 Week commencing 23 March 2015: Outlook for the Australian ASX200
 Week commencing 30 March 2015: Outlook for the Hong Kong HSI50
 Week commencing 16 March 2015: Outlook for the US S&P500

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We spoke about the FTSE last week and highlighted the difference between its
performance and the performance of other European peers like the DAX. One thing
that has really stood out to us over the past week since publishing that report is the
rapid depreciation in the Euro. This is huge and we do not want this to be taken for
granted. It is also important in the context of analysing the S&P500 index this week.
The fall in the EURUSD is an event which we predicted in April last year and although
initially getting our timing wrong, we stuck to our guns and have been pleased with
the gains to date. But we didn’t think the decline would be this savage and rapid.

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Image: Weekly EURUSD price chart via Invast MT4 platform

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In April last year, when the EURUSD was just shy of 1.40, Invast Insights Chief Editor
Peter Esho wrote in his weekly blog post “…The most important part of running a
central bank is maintaining credibility with the market. After all, currencies are just
pieces of paper and worthless unless the market trusts a central bank’s willingness to
come good when required. We often forget about the very basics of monetary policy
when dealing with markets.
For me, the European Central Bank is even more
extreme in that it doesn’t represent a single
sovereign country but a collection of members,
each with their own rules, regulations and
associated political messes. We saw how this
played out in 2012.

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At the end of the day, the Euro is a piece of paper backed by other pieces of paper
which commit European countries to their obligations. As we know, pieces of paper can
be ripped up. Europe has fought many wars over the past few centuries because certain
members decided to rip up pieces of paper or prior conventions...”
This week’s discussion is not on the EURUSD, but the factors behind the EURUSD move
are also very relevant to our discussion point – the S&P500 index. Many traders and
investors were surprised at the huge jump in US jobs last week and the impact it had
on markets, but not those at Invast. Our conviction has been very firmly stated that the
US dollar is on the verge of a long recovery and this was set at the beginning of the
year in our 2015 Outlook Guide (if you haven’t already downloaded the guide, click
here).

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We said the following:
“…Discussion around rising US interest rates will start to increase in the first quarter
of this year. We think this will be a major focus of the market, just how the world deals
with rising US interest rates albeit from record low levels. We think the markets will
cope, just as they did with the tapering of QE3 last year.
There will be initial shocks but nothing that will steer the market off course. Rising US
interest rates will put pressure on global stock market valuations as the discount rate
used to value stocks will rise, in effect reducing net present valuation calculations. This
should be offset by stronger earnings as rising employment and lower energy costs
feed through to the corporate sector. The big question is, what happens towards the
second half of the year as these tailwinds start to reduce.

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We think the greatest threat to markets is complacency, particularly around US stocks
and Apple in particular. We spent some time on this again in November and December
and will reiterate it thought in this report. At some point we feel that Apple will miss
market expectations and the huge market capitalisation will come under pressure. For
the rest of the market to follow suit, earnings growth needs to dry up and again this is
something that is potentially likely in the second half of the year…”

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The only single factor that matters are the moment for the future of the S&P500 is
the direction of US interest rates. The actual interest rate at the end of 2015 doesn’t
not really matter, what the smart money is trying to measure is the direction and
magnitude of future rate rises. The dollar rally is so real and significant to global
markets that we have already seen its impact play out on currencies like the EUR and
AUD. The impact on stock markets is slightly different because stock prices are
impacted also by corporate earnings. But first let’s get the recovery of the US dollar in
context, before moving to corporate earnings.

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In January we put up this chart highlighting the US dollar index:

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Those of you who think the US Dollar recovery is overdone should take a long hard
look at the chart above. Sure, it has moved significantly higher over the past twelve
months, but from a very low base. The US Dollar index at around 91.00 as of the time
of writing is a long way from the high 120.00 range seen in the late 1980s.
Back then, bond yields were in the mid-teens on US 10 year treasuries compared to
the 2-3% range currently being priced by markets. We obviously don’t see those levels
this year, but traders should not be complacent and should not underestimate the
economic recovery we have recently experienced in the United States.

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We said in January that “…We expect to see the US Dollar index further strengthen
this year and at some point edge higher towards the 100 level. This will be driven by
higher interest rate expectations, we will need to see the 10 year treasury yield move
convincingly above 3% and towards 4% or thereabouts before the 100 level on the
index is approached…” As we write, the US dollar index is trading at around the 99.30
level, just shy of our 100 prediction.

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Image: US Dollar futures pricing index, four hourly chart as quoted on Invast MT4 platform

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The US Dollar recovery is a major drag on US corporate earnings, for the two following
reasons:
1) It lowers the value of translated earnings back into US dollar. US companies who
generate their earnings in Euros or Australian dollars are now around 20-30% lower
when they translate back to their home economy purely due to the appreciation of the
US dollar.
2) When interest rate assumptions rise, usually asset prices fall. This is because the
time value of money changes. Investors are now requiring a higher reward for assets,
including stocks, which lowers the price they are willing to pay as they price in a higher
margin of safety.

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This all of course assumes all other things are equal, which they are not. The real test
for US stocks and the S&P500 index is the ability of US companies to grow their
earnings at a factor which is above and beyond the currency and interest rate
impacts to their valuation. To analyse this, we breakdown the top 10 stocks on the
S&P500 and measure their statistical significance. We then provide our commentary
on each of the companies. As you will see, there is more bearish than bullish direct for
these companies and this is the underlying reason, together with a rising US dollar,
that we feel will weigh on the S&P500 this year. The key index weights are:

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Company Weighting Comments
Apple Inc. 3.95%
Depends on how much of a believer you are in Apple’s ability to continue
generating currency sales success. We’re doubtful of the ability to match
recent success, plus has large exposure to sales in Europe which translate
much lower now into US Dollars.
Exxon Mobil 1.96%
It doesn’t seem like energy prices are about to improve any time soon and
as is the case with BHP, BP, Shell etc there will be pressure to write down
the value of current projects on balance sheet, like Gorgon in WA for
example.
Microsoft Corp 1.90%
Winner, we think Microsoft has among the best earnings profile in the
S&P500 top 10 stock list. Core excellent in the SME market and generally
strong corporate profile helps lend support.
Johnson & Johnson 1.51%
Again, a victim of lower translated international earnings from its huge
offshore operations. Limited growth at home meanwhile, acquisitions
becoming more expensive through higher debt.

2020
Berkshire Hathaway 1.44%
Bit of a mixed bag generally. Has usually had strong upside to high
inflation periods and has lagged during bull markets where interest rates
have fallen, so might surprise slightly higher.
Wells Fargo 1.40%
As a financial stock, does not benefit from rising interest rates, although
among the better of the US banks.
General Electric 1.39%
Very similar to Johnson and Johnson in terms of earnings growth drivers,
even though vastly difference business.
JP Morgan Chase 1.24%
Very similar comments to Wells Fargo, JP Morgan maybe even worst off if
balance sheet risks start to emerge from a period of really low global
interest rates. Avoid during rising rates.
Procter & Gamble 1.21%
Very similar to Johnson and Johnson, although does have good growth in
emerging markets. Need to see how significant these are.

2121
Pfizer Inc 1.17%
Will suffer from a rising US dollar, particularly in the next few months. Has
protection through its product depth etc. but currency cannot be ignored
here.
Total Top 10 17.20%

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Image: S&P500 monthly price chart, as quoted on Invast MT4 platform
S&P500 market outlook
What a chart!

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The trend is impressive by historical standards. What history also shows is that markets
do not move in a straight line over a long period of time. The chart above is basically
on long straight line, which to us suggests that the S&P500 rally has run its course. We
would be a seller at current market prices with risk management in place, just in case
we companies we summarised end up surprising massively on the upside when they
report their earnings.

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We think that is a fairly remote and naïve basis. We’ve been cautious on the S&P500
previously and wrong in calling it a sell numerous times last year. But that doesn’t
mean we change our mind, we stick to our overall convictions and see this index
coming lower. More comments and analysis in the webinar, with details below.

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Outlook on major global indices – a correction coming?
Invast Insights chief editor and contributing author Peter Esho will summarise his
outlook on the major global indices in March. Esho will document his findings based
on the performance of key stocks across these indices and where he believes the big
opportunities lie throughout this year. His presentation will focus on the following 5
themes:
Outlook on the German DAX30
Outlook on the UK FTSE100
Outlook on the US S&P500
Outlook on the Australian ASX200
Outlook on the Hong Kong HSI50

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Esho is a regular contributor on CNBC, Bloomberg and host of ‘Your Money Your
Call’. His webinar will cover both the fundamental and technical outlook on these
key themes and a basic introduction to Invast’s new DMA CFD product offering
which complements MT4 and other services. This webinar is expected to fill fast.
Q&A will be open straight after the presentation. Click here to register.

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Go to www.invast.com.au/insights to get a
complimentary 4 week trial and receive the latest
insights as they are published to our live clients.

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Disclaimer
Please note that you are receiving this report complimentary from Invast Financial Services Pty Ltd
(AFSL 438 283). Invast staff members may from time to time purchase securities which are
included in this or future reports. The authors of this report may or may not be holding a position
in the securities mentioned. Please note that the information contained in this report and Invast's
website is of a general nature only, and does not take into account your personal circumstances,
financial situation or needs. You are strongly recommended to seek professional advice before
opening an account with us.
General Disclaimer: This newsletter contains confidential information and is intended only for the
person who downloaded it. You should not disseminate, distribute or copy this newsletter. Invast
does not accept liability for any errors or omissions in the contents of this newsletter which arise
as a result of downloading this newsletter. This newsletter is provided for informational purposes
and should not be construed as a solicitation or offer to buy or sell any financial product. Invast
Financial Services Pty Ltd is regulated by ASIC (AFSL 438 283 | ABN 48 162 400 035).

2929
Risk Warning: It's important for you to read and consider the relevant Product Disclosure
Statement, and any other relevant Invast Financial Services Pty Ltd documents before you decide
whether or not to acquire any financial products listed in this email. Our Financial Services Guide
contains details of our fees and charges. All these documents are available here on our website, or
you can call us on +612 8036 7555. CFDs and Foreign Exchange are leveraged products and carry a
high level of risk and you can lose more than your initial deposit so you should ensure CFD and
Foreign Exchange trading meets your personal circumstances.
General Advice Warning: Being general advice, this newsletter does not take account of your
objectives, financial situation or needs. Before acting on this general advice you should therefore
consider the appropriateness of the advice having regard to your situation. We recommend you
obtain financial, legal and taxation advice before making any financial investment decision.

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