December 12, 2019

Here’s Why Stocks Seem Set for a Mediocre 2020, if Not Worse

A so-so economy, low earnings growth, an un-inverted yield curve, and a stand-pat Fed are part of the mix for a ho-hum year.

Reported by Larry Light

Art by Dadu Shin

It’s not exactly an uplifting vista before us. The consensus outlook for the stock market in 2020 is for mediocre returns, with no recession. Considering the alternative of a bear market—and when has the consensus ever been wrong? —such a blah forecast is acceptable, maybe even comforting.

For 2020, the median forecast is for a mere 4% boost in the S&P 500, according to a Reuters poll of 52 strategists. When you focus on individual calls, many are assuming some sort of deal to end or at least tamp down the US-China trade war, which given the volatility of the situation might be asking a lot.

If the paltry 4% estimate proves to be true, that would make next year’s market return one of the lowest since the financial crisis. In the almost 11 years of this bull market, the average annual return for the S&P 500 has been 14.8%, not too shabby. Jeremy Siegel, the famed Wharton professor, calculates that stocks since the late 1800s have averaged 7% annually.

During the post-2008 recovery, S&P 500 yearly advances have been in in the double digits, except for 2011 (up just 2.1%, due to fears over the European debt debacle), 2015 (rising only 1.4%, with the oil price bust to blame. And last year (the first loss in the period, it was down 4.4%, amid trade war fears and escalating interest rates). With the index ahead 25% this year, and December historically the best month for stocks, the market enters the new year with some degree of optimism.

The history of the stock market shows that it rises over time, with certain bad patches. Those times don’t tend to stick around too long, although they can. The worst bad patch was from 1929 to 1954, a quarter century later, when the Dow Jones Industrial Average returned to its Jazz Age peak level. Some measurements, which factor in dividends and deflation, show the Dow’s mending to be sooner, in 1936. Still even seven years is a long span.

With luck, the next bear market will be brief. The brutal one associated with the financial crisis lasted 17 months (October 2007 to the start of March 2009), when the S&P 500 dropped 54%. Still, the bulk of that was in the fall of 2008, when Lehman Brothers collapsed.

For investors, here are the forces at work that may bring a mediocre market, or at worst a bear one. Most likely, not a roaring bull:

The economic picture: anemic growth, no recession.

Good thing recessionary fears are much abated: Economic contractions (two sequential quarters of shrinking GDP, by one popular measure) or the threat of them are market poison. In the US next year, gross domestic product growth is expected to be 1.8%, not much of an improvement from 1.75% for 2019 and below last year’s 2.9%, per J.P. Morgan.

Elsewhere, expansion is muted, with No. 2 economic power China’s anticipated posting 4.4% growth, if they’re lucky, down from three times that a decade ago and from a projected 5% this year. “Secular stagnation is likely to define the global economy for the next five years,” said James McCann, senior global economist at Aberdeen Standard.

Where else can investors go?

The sprightly sounding acronym for this sentiment, TINA (for “there is no alternative”) holds that equities, particularly US ones, offer the best returns. Given that, no wonder foreign buyers, and American investors too, stay solidly engaged in the US market. While flows out of US equity funds has been the story for much of this year, Bank of America stats show that has reversed in November.

One drag on the market has been energy, which may be getting a bounce back next year amid the Organization of the Oil Exporting Countries’ recent decision of deepen production constraints. “Producers will spend less in 2020, and put supply-demand in better balance,” said Brian Kessens, senior portfolio manager at Tortoise.

True, equities are relatively expensive nowadays, with the S&P 500 price/earning ratio at 24. Still, “values aren’t too stretched,” noted Ryan Nauman, market specialist at Informa Financial Intelligence, as the American economy is in a lot better shape than those of many other major nations. Further, the current multiple is shy of some past lulus, like 32 in 1999, the height of the dot-com craze.

Market volatility has been calm in recent years, with temporary exceptions such as late last year, when a spooked S&P 500 tumbled and fell just short of entering bear market territory (a peak-to-trough slide of 20%). A lot of market observers anticipate higher vol in 2020.

As Shawn Gibson, CIO of advisory firm Liquid Strategies, pointed out, volatility cycles are usually five years long, and we’re in Year 8. More trade turmoil and the US presidential election may be the main catalysts. As Gibson noted, however, high volatility doesn’t necessarily mean the market is tanking.

Earnings return to normal, which isn’t great.

Third quarter earnings dipped 1.1% compared to the same period last year. That’s a comedown from 2018’s 21% earnings advance. For all of 2019, the expectation is for just 1%, rather pathetic. And classically, when earnings decline, so too should stocks. But that’s not what has happened here.

The standard, and persuasive, argument for the market’s shrugging off the earnings deceleration is that the high readings were a brief interlude fueled by the federal tax cuts, which kicked in last year. “That growth was an artificial reality of tax cuts—organic growth was never particularly good; the slowdown in growth is just a return to reality,” Morgan Stanley analysts Philipp Carlsson-Szlezak and Paul Swartz wrote in a research note.

Inverted yield curve disappears, but so what?

The notification has been delivered about this storied portent of a recession. Every time that’s happened in the last 60 years, a recession followed. The yield for the 10-year Treasury dipped below that of the three-month T-bill in March, and switched back in October.

Nonetheless, the signal’s end doesn’t mean that it was invalid. “In a way, the damage is done,” said Campbell Harvey, the Duke finance professor who first spotted the phenomenon, to the New York Times. A curve inversion doesn’t mean that an instant recession is upon us. It simply means that one is in the wings somewhere, perhaps a year off.

The Federal Reserve will be snoozing.

Three decreases recently, of a quarter-point each, marked a turnaround from the Fed’s policy of ratcheting up short-term rates to more normal levels. The rate-raising policy ran into qualms over the trade war and economic slowing around the globe, and the market’s descent. “In 2018, the Fed made a mistake” by its increased tightening, said Olivier Sarfati, head of equities at GenTrust.

Chairman Jerome Powell makes clear that the central bank has no intention of moving a centimeter on rates, unless something drastic happens. In remarks to reporters Wednesday after the central bank chose to stay put on rates, Powell said, “Both the economy and monetary policy right now are in a good place.”

Well, a mind-changing economic mishap surely doesn’t mean a hike in inflation (bringing more rate increases), which has next to no chance of accelerating. That leaves some economic catastrophe (calling for more rate slashing). A complete collapse of trade talks is a good candidate for that.

All too often, of course, market prognostications are a fool’s errand because fate and its handmaidens, unexpected upheavals, can always intrude. “Maybe we’ll have three or five more years of a bull market,” GenTrust’s Sarfati said. Or the opposite may occur.