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10 Reasons the Market Will Have a Good 2019

The stock market's 2018 headwinds won't stick around in 2019

By Luke Lango, InvestorPlace Contributor

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Calendar 2018 is shaping up to be a forgettable one for the stock market. If the year were to end today, the S&P 500 would register a mere 1% gain for the year. That would mark the S&P 500’s third worst year since the 2008 Recession, and it is well below the market’s average annualized return of 10% over the past 90 years.

But, calendar 2019 could be a different story. Multiple headwinds, from extended valuations to rapidly rising rates to higher costs from tariffs, weighed on stocks in 2018. Most of those headwinds won’t stick around in 2019. Instead, they will be replaced by a few tailwinds.

As such, the 2019 stock market outlook is actually quite favorable, despite a choppy 2018. Without further ado, let’s take a deeper look at why.

Reasonable Valuations

Why The 2019 Stock Market Outlook Is Favorable: Reasonable Valuations

The current trailing twelve month price-to-earnings multiple for the S&P 500 is below 18, roughly 100 basis points below the index’s long-term average P/E multiple since 1988 of just below 19. Meanwhile, on a forward basis, the forward twelve month P/E multiple for the S&P 500 is 15.1, more than 100 basis points below its five-year average valuation of 16.4 forward earnings.

As such, valuations in the stock market today are reasonable and seem to price in some pessimism regarding future earnings growth. If that future growth does come in around consensus estimates of 10% and valuations stay stable, then you are looking at a potential 12% total return from stocks in 2019 (dividend yield is around 2%). That is a pretty good return profile, especially with the 10-Year hovering below 3%.

Reduced Growth Estimates

Why The 2019 Stock Market Outlook Is Favorable: Reduced Growth Estimates

As the attached chart from Yardeni Research shows, short-term corporate earnings growth estimates have substantially deteriorated over the past few weeks from above 15% to below 10%. Such a reduction is historically unfavorable, and usually lines up with times of economic uncertainty and broader market weakness.

Importantly, though, the long-term earnings growth rate has actually improved over the past several weeks despite the short-term earnings growth rate falling from 15% to 10%. This means that while growth expectations are reduced in the short term, they remain robust in the long term, as analysts express optimism regarding a trade war resolution and a deceleration of rate hikes. As such, reduced expectations in the near term seem to be creating a long-term opportunity, according to analysts’ earnings growth projections.

Checked Corporate Debt Levels

Why The 2019 Stock Market Outlook Is Favorable: Checked Corporate Debt Levels

Everyone is worried about corporate debt to GDP climbing to levels not seen since prior recessions. But, as Moody’s points out, the better indicator is net corporate debt to GDP, because this discounts liquid assets, which can be used to buffer against leverage. Per the attached Moody’s chart, corporate net debt to GDP hovers around 34.5%, which is above the long-term median level (33.2%), but also below where that figure stood during each of the last three major economic downturns.

Plus, during those downturns, the Fed Funds effective rate was consistently above 5%. Usually, it was much higher. Today, it sits at a measly 2.2%, so there isn’t much pressure which could lead to a debt crisis.

Inverted Yield Curve

Why The 2019 Stock Market Outlook Is Favorable: Inverted Yield Curve

Everyone is also worried about the implications of the yield curve inverting, as the 5-Year Treasury yield recently slipped below the 2-Year Treasury yield. But, the meaningful part of the curve is the spread between the 10-Year Treasury yield and the 3-Month Treasury yield. That spread remains above 50 basis points, per the St. Louis Fed.

Also, while yield curve inversions are a robust indicator of recessions, they often tend to ring the doomsday bell too soon. According to LPL research, the stock market normally peaks more than a year after the yield curve inverts. And, in that year, the stock market usually returns over 20%. Thus, if the yield curve does indeed invert in 2019, we could actually be due for a big stock market rally.

Tempered Expectations

Why The 2019 Stock Market Outlook Is Favorable: Tempered Expectations

Per the attached chart from Yardeni Research, we can see that the stock market’s troubles in 2018 were brought on in part by overly optimistic investor expectations. Investors Intelligence Bull/Bear ratio sharply exceed 3 for most of 2017 and parts of 2018, a sign that there was simply too much bullishness on the Street to be warranted. Naturally, as things in 2018 have progressed worse than expected, this over bullishness has resulted in market weakness.

Now, though, expectations are much more tempered. The Bull/Bear ratio is around the historically normal and neutral level of 2. With expectations tempered and valuations normal, there is a fair amount of pessimism out there. With this level of pessimism out there, the risk-reward on stocks actually skews toward the upside, because bad news seems largely priced in.

Labor Market Strength

Why The 2019 Stock Market Outlook Is Favorable: Labor Market Strength

The labor market remains strong, and in general, labor market strength is supportive of healthy financial markets. Moreover, as the above chart illustrates, labor market conditions are only improving. Outside of some noise, the trend in jobless claims remains down. Prior to each of the past major recessions since 1970, the market top was preceded by a reversal in trend in jobless claims. Specifically, the number of jobless claims started to rise going into each recession since 1970.

This isn’t happening yet. As such, the labor market projects to remain supportive of financial markets for the foreseeable future.

Dovish Fed

Why The 2019 Stock Market Outlook Is Favorable: Dovish Fed

Another important relationship to watch in the credit markets is the spread between the 10-Year Treasury yield and the Federal Funds Effective Rate. Presently, this spread stands north of 70 basis points. Prior to every recession in recent memory, a market top was preceded by this spread going negative.

We are a far ways off from that, and with only a few rate hikes planned over the next year thanks to a dovish Fed, this spread should remain positive for the foreseeable future (inflation should push up the 10-Year yield, too). So long as this spread remains positive, the current bull market in equities should persist.

Trade War Resolution

Why The 2019 Stock Market Outlook Is Favorable: Trade War Resolution

The trade war has been a big deal for the stock market. According to data from Factset, the number of S&P 500 companies that mentioned “tariff” on their earnings call increased by nearly eight-fold year-over-year last quarter, from 18 to 138. Perhaps not coincidentally, analysts concurrently lowered S&P 500 earnings estimates for the fourth quarter by the most since early 2017.

But, there is optimism regarding a trade war resolution ever since the U.S. and China have agreed to a 90-day trade war truce. Granted, we have no idea what will happen during the next 90 days. But, we do know that both the U.S. and China stock markets and economies are starting to suffer as a result of the trade war. As such, with both sides down and desperate for a fix, the prospects of a trade war resolution are now more favorable than ever before. If we get that resolution in 2019, earnings estimates should come back up, and markets should rise with those higher estimates.

Strong Business & Consumer Confidence

Why The 2019 Stock Market Outlook Is Favorable: Strong Business & Consumer Confidence

One of the common themes in the market is that, regardless of stock market noise, business and consumer confidence remain exceptionally robust. Data from Yardeni Research, expressed in the above chart, supports this claim. Yardeni has created an indicator called the National Confidence Index, which is an average of multiple consumer and business confidence measures. That index presently sits at near record-high levels of around 120.

Moreover, this index is on an uptrend. Importantly, prior to previous large market corrections (2000, 2007 and 2015 to a lesser extent), this index trended down and crashed to 100 or lower. Thus, until this index starts to reverse course and head sharply lower, the consumer and business confidence backdrops remain supportive of higher stock prices.

Sustained Economic Growth

Why The 2019 Stock Market Outlook Is Favorable: Sustained Economic Growth

At the present moment, overall U.S. economic growth and output remain supportive of higher stock prices in 2019. Prior to each major market correction in recent memory, U.S. real GDP growth cooled prior to that correction, and ultimately dropped below its long-term average 2.6% rate. This isn’t happening today. Instead, real GDP growth last quarter was above-trend at 3.05%. Meanwhile, real GDP growth is actually improving from a multi-quarter streak of below-trend growth, not falling from a multi-quarter streak of above-trend growth as it did in 1990, 2000 and 2007.

Overall, what we have right now is a U.S. economy just starting to enter a boom phase, not one that is falling out a prolonged boom period. As such, the broad economic backdrop projects to remain favorable for the stock market for the foreseeable future.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2018/12/reasons-the-market-will-have-a-good-2019/.

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