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WHAT IF THE OPTIMISTS ARE RIGHT?

What if the glass is half full?  What if the optimists are right?

 

Although no one can predict the next big more in stocks, and investors don’t want to bet their retirement portfolio on it, it’s not hard to see the case for a bull market in 2020—even after a spectacular year for stocks in 2019.

 

With interest rates and inflation lower than expected and no sign of change in these trends on the horizon, the stock market multiple is higher than normal and arguably could easily go higher.

 
 
 

The Standard & Poor’s 500 index historically trades at a market multiple of 16 to 18 times its expected earnings.  Put another way, the average share in the S&P 500 index historically has been priced at 16 to 18 times every dollar of profit that it’s expected to earn in the next year.

 

Lately, the price of the S&P 500 has been trading well above the normal valuation band, at about 19 times expected earnings.  Normally that would be a bad sign of overvaluation.

 

However, unprecedented fundamentals—negative interest rates in Europe and lower-than-expected inflation—are keeping yields on U.S Bonds low and driving investors into stocks.  That’s expanded the market multiple from 18 to 19.  The chart shows what it would look like if the market multiple continues to stay at 19, above the historical norm. 
 
 
 

The solid red lines represent the upper and lower valuation bands in the past, and the dotted red lines show the trajectory of the stock prices if stocks continue to trade at 19 times earnings.  The black line in this chart shows the price of the S&P 500 through December 4, 2019.

 

The red dotted lines are actual bottom-up S&P 500 operating earnings per share as of December 2, 2019; for 2018 of $161.93 and estimated earnings of $162.21, estimated 2020 earnings of $178.20 and estimated 2021 earnings of $197.64.  The sources of the data are Yardeni Research, Inc. and Thomson Reuters I/B/E/S, for actual and estimated operating earnings from 2015; and Standard and Poor’s for actual operating data through 2014 and index stock price data through December 4, 2019.

 

While one never makes financial plans based on things going right, sometimes the glass is indeed half-full.

 

New economic data published recently from The Conference Board on the leading economic indicators, the Census Bureau on housing starts, and the Bureau of Economic Analysis on real disposable income confirmed The Wall Street Journal’smost recent consensus forecast of economists for an expected growth rate of just under 2.0% for the next five quarters. 

 


 

Please Note:

1Legend is a Fee-Only Advisory Firm.  Fee-Only Means Legend Never Receives Any Commissions.  However, Legend Trades Securities on Behalf of the Client Through a Few Non-Related Institutional Custodians.  As a Result, the Client Often Pays a Small Fee for Mutual Fund Trades for Transactions (Also Known as a Trading Fee or Commission).  Again, Legend Never Receives any Portion of this Fee.



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