With the turn of a calendar, it appears all fortunes have changed for the better. 2019 has had a great start with the S&P 500 Index recovering from last year’s sell-off and rallying more than 13%, its largest first quarter gain since 1998. The sell-off, at the end of 2018, no doubt brought bargain hunters back to the market, softened the Fed’s stance on rate increases, and subdued fears of a near-term recession. Most of the recovery occurred in January. By mid-February, concerns returned about China trade disputes, Brexit, the Fed, and an inverted yield curve; but the S&P 500 Index continued higher, adding another 3.5% during the second half of the quarter. The Index now trades with a 16.3x forward price-to-earnings ratio and appears to be in line with historical averages given the current market environment. An improvement in earnings estimates may be necessary to see the market move materially higher from here.
Looking forward, the Q1 earnings season may be challenging given year-over-year comparisons, dislocations in revenue due to trade disputes/tariffs, and impacts from the longest US government shutdown in history. Some analysts are even projecting that year-over-year Q1 earnings growth will be negative for the S&P 500 Index, but the more important question is, when will earnings begin to show growth again? As of now, 2019 and 2020 earnings per share (EPS) estimates for the S&P 500 Index are $168 and $187 respectively - that’s about 4% growth in 2019 and 11% in 2020.
Additionally, the market is trying to understand what the inverted yield curve means. History shows that this sign portends a coming recession; yet many analysts aren’t convinced and say this time may be different. Regardless, this omen is not an indication of an immediate recession and, historically, the stock market has performed quite well for many months following an inversion. In fact, using the 10yr-2yr treasury inversion as an indicator, the time between inversion and recession for the last three recessions averaged 17 months with the most recent occurrence, in 2008, lasting 22 months. This “lag” seems to be getting longer, and some analysts suggest this time may be different given the extent to which US and Global monetary policy could be impacting the yield curve. Let’s not forget, a yield curve inversion is not a perfect indicator.
Finally, there has been much time spent discussing the reasons to doubt this market, and yet it continues to be very resilient. We believe there are plenty of reasons that the market can continue to make gains. For example, today forward-looking indicators appear mostly positive with only a few indicators neutral. So far, there are no negative indicators, yet. In past recessions, most leading indicators were predictably negative – the opposite of today’s results. The recent fear in the market appears to be coming from the few neutral indicators, but we believe those fears are unwarranted at this time.
Generally, the economy is looking good, but we’re keeping an eye on it. The best thing we can do now is to make sure our portfolios are properly diversified and in line with our clients’ risk tolerances and objectives. Keep focused on the long term and stick to the plan. There’s plenty of opportunity in our future.
The forward price-to-earnings ratio is the price of a stock divided by its “predicted” earnings per share. Diversification does not ensure a profit or guarantee against loss.
