Here’s Why Wall Street is Worried about 2016

November 30, 2015, 8:50 PM UTC
Markets Open In New York As Global Stocks Rise
NEW YORK, NY - NOVEMBER 30: Traders work on the floor of the New York Stock Exchange (NYSE) on November 30, 2015 in New York City. Following the Thanksgiving holiday in America, stocks were little changed in morning trading with the Dow Jones industrial average down 7 points. (Photo by Spencer Platt/Getty Images)
Photograph by Spencer Platt — Getty Images

If you thought this year was a bad one for the market, Wall Street has a message for you: It’s not going to get better soon.

Wall Street’s top strategists are rolling out their outlooks for next year, as they typically do this time of year, and the news for 2016 is not good.

The latest downer comes from Morgan Stanley (MS). In a research note sent to clients over the weekend, Morgan’s top equity strategists predicted that the S&P 500 will rise by just 4% next year to 2,175. The widely watched index is currently at 2,084. And that’s after being up by just 1.5% in 2015.

Last week, Goldman put out its own warning, saying stocks will basically not rise next year. Analysts from Bank of America Merrill Lynch expect things to be a little better. But even they say that the market will only be up by 5% next year. Not a stunner, again given how poorly stocks have done this year. Here are three reasons analysts are nervous about stocks for next year:

Profitability. Morgan Stanley’s warning about the market primarily has to do with profits margins. After years of expansion, Morgan’s strategists think it will be hard for companies to continue to boost profitability. Morgan’s U.S. equity strategist Adam Parker says companies got a big boost from lower oil prices in the past year. That put more money in consumers’ pockets and it also lowered the cost of transporting goods and other input costs. Now that oil prices have already dropped, that tailwind is going away. And Morgan Stanley predicts the growth of the U.S. economy in general will continue to be slow in 2016, up just 1.9%. On top of that, a falling unemployment rate is likely to force companies to hand out raises. Higher labor costs will also hurt corporate profits in 2016.

Stock prices. The average S&P 500 stock has a price-to-earnings ratio of around 17. It’s been higher in the past, but not often. Last week, Goldman’s analysts noted that only 6% of the time during the last 40 years has the median stock traded at a p/e multiple higher than it is today. Worse, Goldman says that stock market multiples tend to fall 10% when the Federal Reserve begins increasing interest rates, which it is expected to do later this month.

Strong dollar. The dollar has been trading near all-time highs versus the currencies of the U.S.’s largest trading partners. That’s not likely to slow the U.S. economy, but it could do some damage to the stock market next year. While exports only make up about 20% of the U.S. economy, they are a much bigger deal for the profits of the large multinational companies that make up the S&P 500. A little over 45% of those companies’ earnings come from exports. What’s more, interest rates tend to boost the value of the dollar. So the greenback is likely to continue to strengthen next year, especially since Europe and other central banks are likely to leave their local interest rates low, even as the Fed increases interest rates in the U.S.

The good news is that Wall Street has a lousy track record of predicting where the market is headed. Barry Ritholtz notes that Wall Street strategists are no better at predicting the future than your typical tea reading mystic. Last year, for instance, Wall Street strategists on average predicted the S&P 500 would rise by just over 7%. It didn’t come close to that. And given the lousy year stocks have had, it’s not unusual for Wall Street analysts to be coming into 2016 with muted expectations. Our vision of the future is often heavily guided by the recent past.

Even so, Wall Street strategists tend to be a bullish bunch. History suggests they tend to overestimate the performance of stocks. Since 2002, Wall Street’s strategists have on average predicted stocks would rise by about 9%, according to research from Birinyi Associates. The actual rise during that time was more like 6%. So if Wall Street analysts are nervous for next year, perhaps we should be as well.

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