As we look back a decade ago, the stock market had just endured a two-year sell-off, and the unemployment rate was at 9.9% (just shy of the 10% peak reached months earlier in October 2009). Combined, these realities made the idea of investing money in the stock market a hard pill to swallow for many investors. Ten years later, the S&P 500 has advanced more than 188% (excluding dividends), and the unemployment rate stands at 3.5%, a 50-year low. Investors certainly have reasons to feel more optimistic. Yet $13 trillion remains in deposits at domestic banks, according to the Federal Deposit Insurance Corporation (FDIC) — more than ever before.
As you think about what to do with your extra cash in 2020 and beyond, what opportunities and risks should you consider with regards to your investing time horizon and risk tolerance?
Driving forces in 2020
The consumer has been the trustworthy driver of the economy over the past several years — a trend that can continue if wage growth (which has supported spending growth) remains on its current trajectory. For small business employees and low-wage workers, pay checks are increasing at a more rapid pace than the overall job market. Small businesses reported a 4.1% jump in their employees’ weekly earnings in December, the fastest increase since 2012. And the bottom quarter of low-wage workers received a 4.5% increase in their paychecks year-over-year in November (compared to 3.1% nationally).
Minimum wage increases that went into effect on January 1 will help wages for lower-wage workers continue to rise in 2020.
Rising wages help maintain high levels of consumer sentiment. Encouragingly, consumer expectations for the future, which are a component of the overall consumer sentiment index, have been on the rise over the past four months. Historically, this trend has been considered a positive economic indicator and has supported higher equity prices. And I think we’ll see this pattern confirmed as the year progresses.
Consumer expectations 3-month moving average vs. S&P 500
Source: Ally Invest, University of Michigan Sentiment Index, St. Louis Fed.
Support from central banks
The Federal Reserve Board has also played an important role in keeping the economy on track and supporting higher stock prices. In 2019, the central bank began to walk back the interest rate tightening cycle of 2018 with three rate cuts, easing their monetary policy and adding liquidity to the system. Fed Chairman Jerome Powell also announced plans to stay the course on monetary policy in 2020 and said the central bank would remain “on hold.” Last September, the Fed initiated overnight repurchase agreement (repo) operations that fund short-term borrowing by banks. This approach ultimately helped keep interest rates within its targeted range of 1.5% to 1.75% and added additional liquidity to the market, once again expanding the Fed’s balance sheet. Some have likened this move to the quantitative easing, or QE, policy that the Fed pursued in the wake of the financial crisis.
These actions are expected to continue through the second quarter of 2020 and, when combined with interest rate policy, should provide upside support for risk assets, like the stock market.
Globally, central banks are expected to maintain easy money policies in 2020. China kicked-off the new year by cutting interest rates by 50 basis points, the eighth reduction of this cycle, and announcing a $115 billion liquidity injection for the banking system.
I’m anticipating that corporate earnings will become a more important factor for market returns in 2020. The current consensus expectation is for S&P 500 earnings growth to return to about 8%, up from 0.4% expected in 2019. Given 2019’s lack of earnings growth and the market’s rally, the forward 12-month price-to-earnings (P/E) multiple on the broad index has expanded to 18.5x, which is ahead of the 10-year average of 15.6x. Low levels of inflation and low interest rates have also allowed for a higher multiple than the historical average, as the power of today’s money won’t deteriorate as quickly in that type of environment.
As discussed above, I don’t expect interest rates to move higher in the upcoming year. But inflation could have the potential to overshoot the Fed’s 2% target as wages rise and commodity prices move higher, led by a possible improvement in China’s economy and their purchases of American agricultural goods. Higher inflation and steady interest rates would make additional multiple expansion a bit more difficult to achieve.
Earnings-per-share (EPS) growth of 8% in 2020 is just below the long-term average annual growth rate of 10%. Considering most economists expect another year of moderate GDP growth (about 2%), that sounds like a reasonable estimate. The problem is that earnings growth expectations for the year ahead are usually the most optimistic at the start of the year. On average, the annual S&P 500 EPS growth rate is reduced by 4.8% points by the end of the year. That would imply that EPS growth on December 31, 2020 could be 3.2% — much lower than the historical average. It would also imply multiple expansion to 19.3x at the current market price. The last time the S&P 500 was that expensive was at the end of January 2018, right before a near 9% pull-back over 13 trading days.
Changes (bps) in S&P 500 consensus vs. EPS growth estimate by quarter
Source: Ally Invest, S&P Capital IQ.
The big takeaway here is that the market is beginning to feel expensive. While equity prices can move higher as earnings estimates are reduced, the upside will likely be limited until profitability expectations stabilize and clarity on the inflation outlook becomes understood. Inflation will play a key role in the potential for future earnings growth and valuation.
While the consumer remains strong, the manufacturing sector in the U.S. has recorded five months of contraction through December 2019, according to the Institute for Supply Management’s PMI reading. Industrial production, another data point measuring the health of the manufacturing economy, has also declined for three straight months. That said, there are early signs of a recovery in manufacturing data abroad, which began contracting before U.S. data did. The J.P. Morgan Global Manufacturing PMI index returned to expansionary territory in November and December 2019, following six months of contraction as business confidence rose (though still at a low rate historically), and new orders turned positive for the first time in seven months. The global trend is encouraging, though sustaining the improvement will be key for global growth to surprise to the upside in the coming year.
Other indicators to watch
In the near term, the trade conflict with China will undoubtedly have an impact on all of the factors I’ve discussed here. From our perspective, this continues to be the top market risk as we enter 2020.
The phase one trade deal between the U.S. and China, set to be signed in Washington, D.C. on January 15, is the most encouraging progress between the two nations since this conflict began more than a year and a half ago. But it doesn’t guarantee we are out of the woods with regards to trade. On the bright side, corporations are managing around the situation, and they have cycled the initial implications. At the same time, CEO confidence remains weak and capital spending plans have not yet picked up pace. I’m hopeful there is a resolution before the presidential election in November, but it’s far from certain.
The development of geopolitical tensions in the Middle East also presents another risk for investors to consider as the new year begins, but more information will have to be digested before a long-term direction related to this situation can be determined.
From an economic perspective, the Leading Economic Indicators Index (LEI) and jobless claims have been showing signs of deceleration. Both economic indicators are worth keeping an eye on, as they have signaled a coming recession after declining in the past.
In conclusion, 2020 might not be a blowout year like 2019 was for the stock market (up 30% with dividends!). But for the long-term investor, it may be worth wading out any volatility for another year of positive returns. I continue to have faith in the consumer but would like to see capital spending begin to re-accelerate to drive economic and earnings growth.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.
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