The S&P 500 Will Go Higher but Investor Patience is Necessary

Stocks are supported by strong fundamentals, but political noise and valuation risks will cause interim choppiness

There’s been a lot of talk recently about how the stock market — specifically, the S&P 500 index –– hasn’t gone anywhere in a long time. Indeed, since the U.S.-China trade war started in late January 2018, the SPDR S&P 500 ETF (NYSEARCA:SPY) has gained just 4%.

SPY ETF: The S&P 500 Will Go Higher but Investor Patience is Necessary
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A pedestrian 4% over the course of the past 20 months? That’s nothing. The average annual gain for stocks since 1950 is about 7%. We are at about half of that… over nearly double the time frame.

In the long run, stocks and the SPY ETF will breakout to the upside. Recession talk is overstated, economic fundamentals are solid, current headwinds will turn into tailwinds, and valuations remain normal. But, in the short run, stocks will continue to trade sideways, because there’s simply too much political noise at present to warrant a big move higher in stocks from current levels, which seem appropriate given the fundamentals.

As such, the SPY ETF should be seen as a “near-term pain, long-term gain” situation. For the foreseeable future, the SPY ETF will likely continue to bounce around, without netting much of a gain. But, over the next two to three years, the ETF should charge higher as stocks move past today’s noise. Plan your portfolios accordingly.

Stocks Will Charge Higher Medium Term

In the medium-to-long term, stocks and the SPY ETF will charge higher.

The rationale is simple. We aren’t crawling into a recession. Yes, there are warning signs out there, like contracting manufacturing activity, slowing services activity, the yield curve inversion, negative corporate earnings growth, and a plethora geopolitical risks. But, this feels an awful lot like 2015/16 – not 2007/08.

That is, we are slowing, not dying.

True, there is a lot of geopolitical noise and slowing growth (like we had in 2015/16). But, unlike 2007/08, we don’t have a debt problem (today’s elevated debt levels remain in check by low rates and strong cash balances), the labor markets remain very healthy (the unemployment rate started creeping up in 2007 prior to the crash, while the unemployment rate today continues to drop), the headwinds affecting growth (the trade war and having interest rates ahead of inflation) can be walked back, and there has been and projects to remain a ton of fiscal stimulus in the economy (whereas prior crashes/recessions were precipitated by a notable lack of fiscal stimulus).

In other words, the economy is slowing, but it’s still on solid footing. For stocks, that means corporate profit growth should remain fairly healthy over the next several years. Healthy profit growth coupled with today’s historically normal market valuation, implies that in the medium to long term, the SPY ETF should march higher from here.

Beware Near-Term Political Noise, Valuation Risks

In the near term, however, investors should heed political noise and valuation risks, as those two factors will likely keep the SPY ETF stuck in neutral for the next few months.

Specifically, there’s a ton of geopolitical noise out there right now. You have the trade war with China, and that tiff only seems to be getting bigger, as actors and industries like the NBA, South Park, and video games have been dragged into the mess. On top of that, there’s an impeachment process taking place in Washington, for one of the most controversial U.S. presidents in history. Even further, you have Brexit, tensions in the Middle East, and tensions in Southeast Asia.

Indeed, according to BlackRock’s geopolitical risk indicator, geopolitical risks today are as high as they’ve ever been in the past decade. Stocks won’t march higher against that backdrop. Just look at other periods of high geopolitical risk — late 2011/early 2012, and late 2014/early 2015. Stocks didn’t perform great during those eras.

This is also complicated by the fact that, according to most numbers, the S&P 500 index is exactly where it should be right now. Consensus Street estimates peg S&P 500 EPS at roughly $163 in 2019. The median trailing price-to-earnings multiple for the index over the past thirty years is 18. An 18 earnings multiple on $163 in EPS implies a 2019 price target of 2,934.

Thus, political noise and valuation risks will likely keep the SPY ETF stuck in neutral for the few next months.

Bottom Line on SPY ETF

Economic fundamentals are solid, and valuations are relatively normal, so stocks and the SPY ETF will march higher in the medium to long term. In the near term, however, political noise and valuation risks will keep stocks range-bound. As such, the SPY ETF is a classic situation of “near-term pain, long-term gain”.

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


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