2015 corporate profits: Gains expected, but Fed is a headwind

I don't make predictions on where the S&P 500 will end up next year, but if you look at what usually powers gains in the stock marketcorporate profits or multiple expansionit seems more likely that any gains will come from increasing corporate profits. Increasing the multiple is possible, but there are many headwinds.

Let's talk about earnings growth. Until recently, most analysts were expecting earnings gains of roughly 9 percent for the S&P 500 in 2015—not far from this year's expected 7.5 percent gains—and low-single-digit revenue growth, according to S&P Capital IQ.

Unfortunately, thanks to the big drop in oil and its impact on energy stocks, there has been some disappointment on that front in the past couple weeks.

Just two weeks ago, 2015 earnings growth was estimated at 8.8 percent. As of Tuesday, it's down to 7.6 percent. Revenue is expected to grow an anemic 1.4 percent.

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Most of this is due to an expected drop in oil company profits. A couple weeks ago growth in the S&P Energy sector was expected to be down 13.6 percent next year. Now it is expected to be down 21.3 percent.

That's a notable drop. Remember, Energy is roughly 9 percent of the S&P 500.

This would still be record-high territory for corporate profits, but it would be similar to the gains made in 2014. Not a disaster, but no acceleration either.

What about valuation? I don't particularly get the idea that stocks are overvalued. 2015 estimates are at $125.66 for the S&P 500, that leaves the price-to-earnings ratio at a little over 16 (2090/$125.66 = 16.6).

This is a little higher than the historic average, but I still would not call that overvalued, particularly with the economy expanding.

When I look at interest rates, with the 10-year yield at 2.2 percent, it's hard to argue that stocks are expensive on a relative valuation basis. I agree that the biggest threat to stocks in 2015 is a sudden, rapid rise in rates.

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Can multiples expand? There are some clear tailwinds for stocks going into 2015:

1) Dividends are growing.

2) Labor markets are recovering.

3) There are early signs of above-trend wage growth.

4) Consumer confidence is improving, as are other gauges of confidence in housing and small business.

5) Lower energy prices would benefit heavy users of energy (materials) and consumers.

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But there are headwinds as well:

1) Any changes in central bank policy, particularly a tightening by the Fed; indeed, the yield curve has been somewhat flatter as short rates have been moving up in anticipation the Fed would be raising rates.

2) A sudden ramp-up in inflation that is well above expectations, which historically has been a headwind for stocks; oddly, sustained deflation also has been a headwind.

3) Continuing sub-par global growth, particularly in Europe and China.

4) The failure of revenues to keep up with profits, which has made value investors claim the market is overvalued. Sure, if you are a value investor, the price/sales ratio looks unattractive. I get that: earnings up about 8 percent, revenues up 1.4 percent. For another year.

  • Bob Pisani

    A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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