Each year at this time, we find it instructive to review our forecast from a year ago compared to what actually happened. It helps put things into context as we make our fearless forecast for the New Year. Last year’s forecast was pretty good. Fortunately, where we were wrong, it was because we were not sufficiently optimistic.
For 2019, we would grade our forecast a solid B. Our economic growth and inflation numbers were on the money. Our forecast for earnings for the S&P 500 were quite close. And, as we predicted, the second half of 2019 was great for stocks as gains in earnings for 2020 came into focus. We thought the S&P could have a 15-20% year as it recovered from 2018. We underestimated as the index returned about 29%. We thought gold would do well, and it rose some 19%. We thought bonds would have positive returns, but did not imagine them returning 8%.
Being an economist, I think a bit like the Federal Reserve, so I predicted that they would be raising short term rates as unemployment broke below 4%. Correct, but they over did it and had to back down, boosting bond prices. Oil prices rose 34%, and stayed in the $50- $70 range. I thought that most of last year’s risks (i.e. Brexit, China trade, Fed overshoot, etc.) would work out. They did, thus removing a lot of the wall of worry the market climbed throughout the year.
That, unfortunately, is the biggest obstacle for 2020. Stocks have done so well that Sentiment is dangerously bullish. The Investor Intelligence Survey shows close to 60% Bulls, a clearly overbought position. So, sometime in the first quarter, expect a selloff to take some of the enthusiasm out of the stock market. A pull back to the top of the old trading range at 2900 on the S&P would be a good buying opportunity.
So, for 2020 we see no reason why economic growth can’t continue to come in at more than 2%. Inflation is likely to break above the 2% goal that the fed has been chasing. In that scenario, earnings for the S&P 500 would be about $175. With interest rates where they are, the index could sell at a price/earnings multiple of 20, or 3500 on the upside. So, we expect a trading range of 2900-3500 for the year. At year-end 2019, the index closed right in the middle at 3230.
Our forecast for 2020 then is a flat to slightly up year for the S&P, with many trading opportunities. Small and midsized stocks should do better. Large foreign stocks and emerging markets should do even better as the dollar continues its weakness that began a few months ago.
The S&P 500 could reach its high around midyear. Several serious concerns will emerge, including the election, of course. Also, the market will likely anticipate that 2021 earnings could be flat as corporate profit margins continue to decline. And concerns about Federal Reserve tightening could resurface.
The Federal Reserve will not raise rates until after the election. However, if their ongoing attempts to get inflation above 2% bear fruit, I would expect them to start tightening early in 2021. We all remember how stocks and bonds suffered in Q4 of 2018 when the Fed started tightening. Rising inflation presents the biggest risk to the markets.
As for bonds, US Treasuries will likely do better than Corporates in the volatile environment we see. And the 10-year Treasury should trade back above 2% in the first half of the year. Tax free municipal bonds should continue to offer the best after tax returns. I would suggest a commitment to Treasury Inflation Protected Securities (TIPS) for part of your portfolio.
Gold should be among the best performing assets again in 2020 as the dollar continues to weaken. Oil could establish a new, higher trading range of $55- $75 with supply constraints from Saudi Arabia and diminished investment in US shale.
Stay the course for now. Watch inflation and the Fed. That is where the short term risk is. Over time, stocks remain the place to be.
Have a happy, healthy, peaceful New Year!
A note from WSC and WAMI . . .
Robert C. Davis is a Chartered Financial Analyst and is affiliated with Woodlands Asset Management, Inc. as a consultant. Founding partner of Davis Hamilton Jackson and Associates, a Houston based investment advisory firm; Bob is now retired and living in Chappell Hill, Texas. He now lends his expertise and knowledge of the markets to our company and customers. We hope you find it interesting and insightful.