Since the beginning of the new year, the S&P 500 has managed to post gains of roughly 3.2% and many analysts on Wall Street believe that this short-term bullish trend may have set the stage for another strong equity market performance in 2020.
Of course, these bullish forecasts are not entirely surprising. Last year, it was undeniable that the S&P 500 had one of its best performances on record. For longer-term investors with exposure to the index, total returns surged by 33.1% when we include gains derived from dividend reinvestment strategies.
Similar moves were seen in the Dow Jones Industrial Average and NASDAQ Composite, where valuations rose by 22% and 35%, respectively.
However, this extended enthusiasm fails to reflect significant weaknesses in the market’s underlying fundamentals. Unfortunately, the deep disconnect between perception and reality has put passive investors at risk after so many decided to start buying near the highs. Storm clouds are building on a number of different macroeconomic fronts and revisions to corporate earnings expectations have shown consistent vulnerabilities in the outlook.
For these reasons, it makes sense for investors to take a step back from the exuberance that characterized equities markets in 2019 an instead focus on the asset classes most likely to outperform over the next five years.
According to Michael Schoonover of Catalyst Insights, the 2020s may turn out to be the next “lost decade” for stock investors because passive portfolio strategies have entered a period that might be characterized by long-term underperformance. Mr. Schoonover explains that today’s environment is “defined by low-to-moderate growth and relatively flat corporate profits in combination with significant geopolitical risks and monetary policy that will eventually need to become less accommodative.”
According to Dubravko Lakos-Bujas of J.P. Morgan, the bull market in stocks could continue to generate gains for investors this year but underlying profit growth depends on a favorable outcome in the U.S. - China trade discussions. Recent estimates from Lakos-Bujas suggest that the effects of trade war tariffs have already cut the S&P 500’s collective profit figure by about $6 per share. If these external geopolitical factors continue to impact stock valuations, we could start to see a wave of momentum selling hit markets in the months ahead.
According to Ray Dalio of Bridgewater Associates, this shifting paradigm will result in a “combination of large deficits that are monetized, currency depreciations, and large tax increases.” Dalio’s view that bonds and fiat currencies should no longer be viewed as a safe way of storing value has even led to notable commodities positions in gold as a viable asset alternative. Unfortunately, that might not be a strategy that works for all investment portfolios.
For equities investors, this really means that it’s even more important to ignore the technical momentum and focus on the market’s underlying fundamentals. Of primary importance here is the fact that Wall Street’s consensus estimates for the fourth quarter of 2019 indicate an annual earnings decline of -2.6% in the S&P 500.
If these projections are correct, it will mark the fourth consecutive quarterly earnings decline for the S&P 500 and forward P/E multiples in each of the market’s central stock benchmarks have moved to levels that extend far beyond their long-term averages.
So, while last year’s equities gains still deserve a certain amount of enthusiasm, it makes sense for investors to consider reassessing the outlook as we start trading in 2020.
Richard Cox is a personal investor with more than two decades of experience in the financial markets. He is a syndicated writer, with works appearing on CNBC, NASDAQ, Economy Watch, Motley Fool, and Wired Magazine.
© 2022 Newsmax Finance. All rights reserved.