Before I get into my expectations for 2020, let’s review 2019. From trade war to mid-east unrest and impeachment, 2019 has been full of economic and political news, which could have driven portfolio returns lower, but riding a triple rate cut tailwind, we sat with gains in excess of 31% on the S&P 500 index as of December 30.
A large contributor to 2019 financial market positives was the supportive employment situation. The U.S. worker enjoyed the benefit of unemployment remaining well below average, even for great economic times. The current unemployment rate sits at 3.5%, and personal income continues to outpace inflation. This situation keeps consumers happy, and a happy consumer makes for great news when almost 70% of economic production is generated by consumption as is the case in the United States. I believe as long as that continues, times should be good for investors.
By now you’re probably asking, “so what happens next?” I’m getting there, but one caveat before making a call. The past three years have been anything but normal. Volatility in 2017 was non-existent, and the S&P 500 rewarded investors with a 21.88% return including dividends. Volatility returned in 2018 when I estimated a 6% to 8% annual gain on the S&P 500. By the end of January 2018, the S&P 500 had gained 7.54% in that first month. Little did I know the market would get slapped backward through mid-February to lose its gain, rebound through the summer and get beaten down again in the fourth quarter for an annual loss of 4.37% for 2018. Obviously, volatility in equity markets had not been solved. I made a similar call for 2019, a gain of 6% to 8%, but here we are more than 30% higher. Needless to say, financial market forecasting is very difficult and can be a great source of humility, generally unwelcomed humility.
On the negative side, valuations are at a 29.7% premium according to long-term average price-to-earnings ratio (P/E) for the S&P 500; the election is very likely to get ugly, although impeachment has hardly moved the financial market needle; a trade war that is seemingly headed toward resolution; corporate earnings are seemingly slowing, and interest rates are not likely to decline in 2020. On the positive side — and these are strong positives — interest rates are low, employment is strong, wages are growing, and inflation is low. Ultimately, I am still stuck in valuation mode, which I generally struggle to avoid. That being the case, I find it hard to believe we will not revert to the mean P/E (around 16.6) at some point in the future, but it may be further out the horizon than 2020. I would be surprised if financial markets continue to give us gains while corporate earnings struggle. Fourth quarter 2019 earnings reports, which will begin in January, will tell us what to expect in the first half of the year. Given that long-term average annual returns on the S&P 500 using information back to the late 1920s show us a 10.5% average gain, I believe 2020 is likely to be below average. I believe the market could return half that and I would be happy, rounding to 5% for those who insist on a specific number is fine with me. Using a range to avoid any appearance of overconfidence in my forecast would put me at numbers between a loss of 10% and a gain of 20%, but who wants to hear that noise?
Happy New Year!