The current bull run seems to have nine lives and Wall Street largely is looking for it to continue. But stock gains in 2020 may not be as sparkly as they were in 2019 and Treasury bonds have risen in price, leaving room for extensive conversation over how much risk to take and where to find safety.
Before we get to where to place money for the next year, let’s start with the macro backdrop.
GDP growth is decelerating and is expected to be around 1.7% for 2019. Inflation remains below 2% and the Federal Reserve, while on hold for the moment, is open to cutting interest rates to support the economy, should it need stimulus.
A phase one trade agreement between the U.S. and China provides some assurance that we may soon see a more comprehensive deal. This could lift business investment, hiring and the already growing consumer.
We’re also seeing some upside to current GDP estimates as well as earnings per share consensus estimates on the S&P 500. The current consensus: $177.
Wall Street on S&P 500 in 2020
Most strategists are calling for roughly 3% gains in the S&P 500 for the next year or so. The number was around 5% a few weeks ago, before the phase one deal pushed the index up a bit.
The S&P 500 is up 25% year to date, a rally built on the Fed’s several interest rate cuts, optimism about trade talks and, consequently, a pushed-back call for a recession. Many analysts now put the chances of a recession in the next year at roughly 20%.
The large 2019 gain is what some have called a makeup rally, as an ugly December 2018 selloff spurred by rising rates prematurely intensified recession fears.
But valuations aren’t cheap. The adjectives used to describe current earnings multiples on the S&P 500 are “fairly valued” and “slightly overvalued,” not “undervalued.” The average stock in the index trades at just under 18 times next year’s earnings, above the trailing-10-year average of under 15.
Strategists largely see lower rates as having less and less of an impact on economic growth compared with earlier in 2019. And they see the possibility of a trade-war resolution as an X factor that would provide upside to current EPS estimates.
Some have said stock gains from here will come mostly from continued expected earnings growth and less from higher multiples. Some multiples may rise as analysts begin to use lower discount rates on corporate cash flows, driven by lower rates.
On rates, Canaccord Genuity’s chief market strategist, Tony Dwyer, notes that lower interest rates are starting to stimulate the economy, as seen by recently strong housing data. Dwyer says low rates could also spur both multiple expansion and a reacceleration of economic growth and earnings growth.
Wall Street on Safety in 2020
So what about bonds or other safer assets?
While market analysts see room for upside to stock returns, there’s certainly also room for downside. But the 10-year Treasury price has moved up considerably in 2019, with the yield – which moves inversely to the price -- down to 1.92% from 2.67% at the start of the year.
Since Wall Street has turned slightly more bullish on economic growth of late, many observers see the 10-year yield moving above 2% in 2020. A Fed on hold and better-than-expected economic growth create a recipe for a slightly “risk-on” environment.
But this represents almost no spread over inflation.
Investors hungry for safety and income may want to consider low-volatility dividend stocks, which are less likely to fall in price while offering premium yields.
“We like the dividend payers — we like dividend-growth strategies for sure,” Bank of Montreal Chief Investment Strategist and Head of National Investments Mike Stritch told TheStreet.
“For those looking for other income sources, dividend payers is a good place to be.”
UBS’s Global Wealth Management team wrote in a recent note that in the U.S., “we position our Dividend Ruler strategy with a bias toward higher-yield, higher-quality companies compared to the overall market.”
For example, Coca-Cola pays a dividend that yields 2.96% at present. In telecom, AT&T and Verizon pay 5.36% and 4%, respectively. Con Edison, a highly defensive stock, pays 3.3%.
But which stocks will outperform the market?
Wall Street on Sector Allocation
Some analysts indeed call for defensive picks over cyclical ones, as noted above. But some defensive sectors are home to stocks that are trading at somewhat expensive valuations.
Procter & Gamble, a consumer staple, trades at 24 times next year’s earnings. Peer Colgate-Palmolive trades at 23 times. The cheers for cyclical stocks are growing louder, as economic growth shows better signs and the Fed has managed to strike an accommodative tone without lowering rates for now.
For 2020, “We’re looking more cyclical now,” Stritch said. This “does have more of a bank, [consumer] discretionary, industrial bias.”
Stifel Head of Institutional Equity Strategy Barry Bannister recently said his firm favors industrials, materials, banks and energy.
Industrials have underperformed, rising 22% for 2019. Some large caps like Caterpillar (+16% YTD) have issued warning signs throughout the year, lowering earnings guidance, as macro headwinds and trade uncertainty pressured revenue forecasts. Now, the bellwether trades at a relatively low 13 times next year’s earnings.
As for banks, the State Street S&P Financials ETF has outperformed, at 29% year-to-date. And while price-to-book ratios of bank stocks have ticked up a bit, many of them are far from pricey, below 2. Among those stocks are Bank of America, Wells Fargo and JP Morgan.
A no-longer-inverted yield curve and potentially rising long-term rates would be a positive to bank earnings as well.
A Quick Word on Tech
Big tech and FAANG may not see gains through for the broader market as much as they did in past years.
But analysts note that much lower valuations, coupled with new growth drivers -- such as Facebook’s Instagram and Apple’s services -- could enable those stocks to outperform in 2020. Microsoft is certainly in the same boat, with cloud adoption still in its early stages.