The decline in oil prices could lift GDP in 2015 by 0.5% to 1.5%. It may be tempting to think this will lift stock prices but stocks don’t correlate very well with GDP. Stocks are supposed to correlate with corporate profits. A rise in GDP from extra consumer spending could increase corporate profits however there is no guarantee that the money saved by consumers will be spent at businesses with high or growing margins. If some consumers only shop at low cost, low margin stores then most stocks won’t benefit.
If oil stays low then OPEC countries will reduce spending thus exports of goods from the U.S. to OPEC countries will be reduced, so GDP may not increase that much.
The one year trailing PE is 18 and a fair value should be a PE of 12.5, implying stocks are overpriced by 44%. Even if corporate profits increased in proprotion to a 1% extra increase in GDP the problem is that stock’s PE multiples are too high and need to come down. Now that Quantitative Easing has ended there is the risk that stocks may go down. QE acted mainly as a placebo rather than actually improving the economy.
Corporate profit margins at 11% are way above the average margin of 6%. Based on the historical tendency for margins to revert to the mean there is risk that margins could drop roughly 45%, which is another downside risk for stocks in addition to the risk that PE ratios are substantially too high.
It may be possible that margins don’t mean revert and experience eras when they stay high or low for a long period of time. However they have been high for several years and eventually things that made them high may change. Their elevated levels were due to the damage that some weaker competitors suffered which resulted in less competition. Also elevated profit margins were due to aggressive cost cutting typical in recessions. Eventually the economy will return to normal and the cost cutting will mean revert thus chipping away at corporate profits. Ironically as the economy returns to normal that will trigger a new era when profit margins mean revert down to lower levels. But the growth of the economy will not increase corporate sales enough to offset the reduction in profit from rising costs, so margins will fall and stocks will be worth less even in an improving economy. This is because stocks are overpriced by roughly 100% to 115% which implies the SP500 will drop from its current 2069 points down to roughly 1,000 points.
Investors need independent financial advice about the risks of a stock market crash. I wrote an article “When will the next stock crash occur?”