7 Reasons the Stock Market’s Record Closing Isn’t the End of the Rally

Fundamentals imply that the big 2019 rally in stocks isn't over just yet

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The stock market has had an epic run in 2019. That run hit another milestone in late April, when both the S&P 500 and Nasdaq notched record-closing highs amid a flurry of positive earnings reports. Ultimately, the S&P 500 has rallied 17% year-to-date and 25% from its late 2018 lows. Impressively, it has done so with the biggest downdraft being a measly 2.4% selloff in early January.

In other words, the stock market has come very far, very fast in 2019, done so with mitigated volatility, and has now ultimately completed the “rebound rally” as stocks are back to record highs.

What’s next?

More record highs. To be sure, stocks may trade with slightly more volatility now that we are back at record highs and with earnings season in full swing. But, the medium- to long-term uptrend in stocks will ultimately persist, and the S&P 500 has visible upside to levels north of 3,100 by the end of 2019.

Why? Let’s take a deeper look at why the hot stocks in the market will remain hot for the foreseeable future.

The Economy Is Improving

The biggest reason why the red-hot stock market will keep rallying for the foreseeable future is that the U.S. and global economies are dramatically improving in the new year.

Largely thanks to a 180-degree turn in the Fed from hawkish to dovish, a dash of stimulus from the Chinese government into its economy, reduced global trade tensions and other factors, economic conditions everywhere have improved in 2019. In the U.S., we are now looking at record low unemployment levels, decade-best wage growth, restored consumer confidence, lower borrowing rates and reduced tariff risks. The same is true on most of those fronts across the globe.

As such, the global economy appears to have undergone a mini-slowdown in late 2018, but is now bouncing back from that slowdown in early 2019. So long as this bounce-back persists, stocks will broadly head higher.

Q1 Earnings Have Been Strong

The biggest risk for stocks in early 2019 was the first-quarter earnings season. Broadly speaking, everyone expected first-quarter earnings to be bad, but were looking for second-quarter and full-year 2019 guides to reflect a substantial improvement from depressed Q1 results.

We are now part of the way through the first-quarter earnings season, and the Q1 numbers have been surprisingly good. Around 15% of S&P 500 companies have reported earnings so far. Of that cohort, nearly 80% are reporting earnings above expectations, while earnings in aggregate are coming in more than 5% above expectations. Both of those figures are above their five-year averages.

In other words, the Q1 earnings season has been surprisingly good. If this persists, that would provide confirmation that the worst of the economic downturn is over, and provide a nice lift for stocks.

The Fed Is on the Market’s Side

Theoretically, the Fed is supposed to be on the side of the economy, and do what is best for long-term economic growth and stability, which mostly concerns mitigating the boom-bust cycles inherent to capitalism.

Having said that, the Fed today is clearly in favor of keeping the stock market healthy, too. They were raising rates rapidly in late 2018, and when the stock market threw a fit in response to those rate hikes, the Fed proceeded to stop hiking rates. So long as inflation remains muted and the market remains healthy, the Fed will continue to stay on the sidelines.

Now, let’s suppose the market does fall and economic growth wobbles. History says that this Fed will proceed to cut rates, which will give a boost to stocks and stabilize the economy. As such, the stock market today has a nice safety trigger in a Fed that has some cushion and willingness to cut rates in the event that the economy has another downturn soon.

Earnings Estimates Will Move Higher

During the late 2018 selloff, Wall Street analysts broadly pulled down their forward earnings estimates for the S&P 500, and that weighed on stocks. Simply, the fewer profits companies are projected to earn, the lower their stock prices go.

The opposite is true, too. The more profits companies are projected to earn, the higher their stock prices go. This dynamic could provide a nice lift to stocks for the foreseeable future. Specifically, as mentioned earlier, Q1 earnings are coming in far above expectations. That will naturally provide a lift to full-year 2019 earnings estimates. Strong Q1 numbers also confirm that the worst of the economic downturn is over, and this confirmation will provide an additional lift to forward profit estimates as analysts forecast for growth to re-accelerate.

Broadly, then, Wall Street analysts will likely pull up their forward earnings estimate for the S&P 500 over the next few weeks and months. As they do, stocks should head higher.

Valuations Are Reasonable

The S&P 500 currently trades at nearly 17-times forward earnings. That’s an above-average forward multiple for the index. But, when put in context with what will be rising profit estimates, it’s arguably a discount multiple.

Today, the 2019 EPS estimate for the S&P 500 is roughly $167. Back in September 2018, it was $178. To be sure, it is unlikely that 2019 EPS estimates move back up to $178. But, upward revision toward $170 seems likely, given Q1 strength. Fiscal 2020 EPS estimate are projected to rise 12% from fiscal 2019 EPS estimates. Assuming the same growth rate from a $170 base, that would put fiscal 2020 EPS estimates at roughly $190.

Based on a five-year average 16.4 forward multiple, that equates to a fiscal 2019 end price target for the S&P 500 of over 3,100. Thus, with the S&P 500 trading below 3,000 today, the valuation is reasonable and lends itself to further upside over the next several months.

Trade Tensions Are Cooling

One of the biggest drags on the stock market in late 2018 was rising trade tensions between the U.S. and China. In 2019, though, those rising trade tensions have turned into cooling trade tensions, and the market headwind has become a market tailwind.

This cooling of trade tensions will continue. Trade talks between the U.S. and China will resume next week in a move that puts both countries one step closer to reaching a resolution. From the looks of it, a resolution is probably just weeks or months away. So long as the outlook here remains favorable, stocks will stay in rally mode in anticipation of a resolution that will provide an economic boost to both the U.S. and China.

As such, until news breaks that the two countries aren’t making progress toward a deal, stocks will likely stay in rally mode.

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/2019/04/7-reasons-the-stock-markets-record-closing-isnt-the-end-of-the-rally/.

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