Market Strategy 1/7/2019
Look ahead for 2019 to be a “do-over” year
As 2018 fades into the rearview mirror, it will be likely be remembered as “the year when good wasn’t good enough.”
We initiate a year-end 2019 price target for the S&P 500 of $2,960 or 16.9x our 2019 EPS estimate of $175.
Ironically stocks were at record highs in late September and seemingly in reach of our 2018 target of $3,000 before being ultimately overtaken by negative projections related to:
- Economic growth (domestic and international),
- The trade war with China,
- Fears about the direction of Fed monetary policy,
- And a precipitous drop in the price of oil.
This resulted in a fourth-quarter drawdown that brought equity prices lower than where they began the 2018 calendar year and at a level last seen in April of 2017.
With the last Federal Reserve decision of the year behind us and the market having gone through a dramatic pullback since, we believe that barring a “black swan” event, or the shock of a bolt from the blue, the worst of the declines experienced by stocks in 2018 are behind us.
We expect that the decline of the stock market after the last Fed FOMC meeting may be recognized in hindsight as the market’s “Fed hike tantrum of 2018.”
We believe the significant drawdown in Q4 and particularly in December was largely driven by technical factors and algorithmic trading as opposed to a deterioration in economic and corporate fundamentals. We note that while the price of the S&P 500 declined over 14% in the fourth quarter, bottom-up estimates for 2019 earnings growth declined just 2.5% in the same period as per S&P Dow Jones Indices.
We see increasingly negative sentiment setting the stage for upward surprises in 2019, with a reset in valuations and the potential for better than expected fundamentals an attractive risk/reward opportunity set for global equities. With what we believe to be almost all but the kitchen sink priced into current valuations, we see opportunity for multiples to return to levels seen at the end of the third quarter, with multiple expansions resulting in a global equity rebound in the coming year.
With Q3 earnings season having shown ~32% growth in year-over-year operating earnings, the S&P 500 has now delivered nine consecutive quarters of EPS growth (six of which have been over 20%). Bottom-up estimates for Q4 2018 point toward another quarter of double-digit year-over-year growth, with full 2018 calendar-year estimates slightly exceeding 25% year over year.
We see expectations of 11.5% operating earnings growth in 2019 as realistic given continued strength in consumer spending, wage growth, cost-cutting, and share buybacks. While 2019 faces tougher year-over-year comparables due to the one-time boost from tax reform in 2018, positive effects remain beneficial to corporations.
That said, we do not expect a rally of great significance to emerge until sometime into the first quarter of 2019, likely driven by material progress in talks with China, or better than expected economic data to counter the negative projections that have roiled markets in recent weeks.
We look for market risk to weigh on investor sentiment into the new year until catalysts for a rally of some material significance appear on the scene.
As we go to press the bear camp remains steeped in negative projection for the outcome of challenges presented by the Fed’s commitment to interest rate normalization, the trade war with China, the recent precipitous decline in the price of oil as well as prospects for tougher comps in earnings seasons in 2019.
Positive catalysts for the stock market are likely to come in the form of:
- Material progress in trade talks with China,
- Positive surprises in fourth-quarter earnings season,
- Fourth-quarter and full-year 2018 GDP numbers,
- Further clarification and better communication from the Federal Reserve,
- As well as from the effects of a political transition in Washington reflecting changes in leadership in the House of Representatives.
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