With stocks about to finish off a remarkably lucrative year, investors this holiday season have reason to rejoice. Barring a late-year selloff like we experienced last year, opening quarterly 401(k) statements in the new year is likely to be an enjoyable exercise for our individual and institutional clients in Southwest Washington. Benchmark indexes like the Dow and the S&P 500 have returned over 20% in 2019. In stark contrast to 2018, asset classes from stocks-to-bonds, large cap-to-small, have produced positive returns for investors.
A lack of earnings growth in 2019 and the ongoing trade war with China failed to deter stock prices as three Fed rate cuts injected new liquidity into the economy. At Ferguson Wellman, we pair holiday celebrations and cheer with another tried and true ritual – offering our outlook for the economy and stock market for the upcoming year.
Whether Mick Jagger and the Rolling Stones, a 90-year-old marathon runner or the U.S. economy charting its record 11th consecutive year of expansion, we are focused on the idea that age isn’t the ultimate arbiter of success.
What’s different this time around? The U.S. economy invests more than ever in intellectual property, that being research and development spending to develop cancer fighting drugs, big data analytics and cloud computing technology. At the same time, investment in traditional manufacturing has diminished, to the extent it now accounts for only about one-eighth of the U.S. Economy. The result is a predominately service-based economy less prone to inventory swings that, in the past, underwrote boom-and-bust periods.
Former MIT economist Rudi Dornbusch once observed, “Economic expansions don’t die of old age, they die of excess.” Exhibits A and B for excess would be the overinvestment in technology that set stage for the 2002 recession and the real estate boom that went bust, spawning a severe recession six years later. Although always susceptible to “black swan” type of events like 9/11, the U.S. economy today lacks the characteristic excess that historically has called the Fed into action. Despite a robust job market sporting the lowest unemployment rate in 50 years, our central bank is still trying to elevate prices to its two percent inflation target. Corporate confidence and investment have waned with tariff uncertainty and trade restrictions, but that hasn’t stopped the U.S. consumer, which remains the locomotive of the U.S. economy by accounting for two-thirds of GDP.
While we may have returned to “muddle-through” economic growth following stimulus provided by the 2017 tax cuts, the U.S. consumer is gainfully employed and spending more each year. Accordingly, we expect the U.S. economy to continue its record-breaking expansion in 2020.
Dovetailing with our economic outlook is a Fed we see moving to the sidelines next year. Money supply figures show its most recent rate cuts having their intended effect, supporting aggregate demand and security prices. While interest rates are likely to remain lower for longer in the U.S., negative interest rates in Europe and Japan are unlikely to wash ashore in the U.S. Simply put, our economy has more dynamic labor markets, is less regulated and has better demographics.
All of which brings us to the 2020 elections. While non-presidential election years tend to be better for stocks, election years in general have produced double-digit equity returns. However, what will be critical around election time is the health of the economy. During times of rising disposable income growth, sitting presidents overwhelmingly win re-election. Investors will also keep their eyes on the congressional races.
While we are not in the business of predicting election outcomes, we believe that positioning on key issues will moderate as the election approaches. Despite the campaign rhetoric, we expect policy changes to be more evolutionary than revolutionary, and our anticipation is that neither party will win a congressional majority and the presidency. In other words, we expect divided government and a degree of gridlock – benign outcomes generally supportive of investors’ capital.
So, where to for the stock market? Equity valuations are no longer “cheap,” and corporate earnings have gone flat in recent quarters. This is a result of a stronger dollar dampening the translation of multinational companies’ foreign earnings and rising labor costs in the U.S. Nevertheless, equities rarely decline outside of periods associated with recession, and without one in sight, we don’t believe investors should bet against equities in 2020. Admittedly, consensus estimates calling for 10% earnings growth appear too high for next year, but what we can envision is mid-single digit earnings growth the result of 4% estimated nominal GDP growth, a weaker dollar, more moderate labor cost inflation and share buybacks financed by strong corporate cash flow.
With rangebound interest rates in the forecast, we aren’t anticipating a continuing expansion of price-to-earnings multiples, but in a continued low-rate environment where investment income is harder to find, investors may increasingly gravitate to equities sporting above-average dividend yields. Of particular interest to us are such companies likely to continue increasing their dividend payouts as earnings expand. All things considered, we expect equities to make forward progress again in 2020, though not at the same rate as what investors enjoyed this year. As Mick Jagger might observe, don’t let the age of this economic cycle be your “beast of burden.”
Shawn Narancich is executive vice president, research and portfolio management, with Ferguson Wellman Capital Management. He can be reached at email@example.com.