As Wall Street starts to sharpen its view of how U.S. stocks will perform in 2020, two key investment banks, Stifel and UBS, expect U.S. stocks to return about 5% for the next year or so.
The S&P 500 is up 24% year to date, albeit after an ugly December 2018 selloff. And while some observers are cautious on U.S. stocks, many strategists and wealth managers are saying that, late in the economic cycle as we are, the market still has a little upside left.
Stifel's head of institutional equity strategy, Barry Bannister, wrote in a note he is moving his December 2020 price target on the S&P 500 to 3,265 from 3,100. That indicates roughly 5% upside from the index's current level of 3,108.
Recent optimism that a U.S.-China trade deal will materialize has lifted expectations of economic growth. Along with that, GDP growth was 1.9% stronger in Q3, beating expectations of 1.7% and prompting some to push back their expectations of a recession. The S&P 500 is up 7.4% since Oct. 8.
Bannister touts a potential resolution to the trade war as a development that could derisk U.S. stocks.
And while a hard trade deal could send the market soaring, since that could improve corporate fundamentals, the recent Federal Reserve interest rate cuts could also soon provide a lift to stocks.
Fed Chairman Jerome Powell noted in mid-November that monetary policy operates on a lag, meaning that when the Fed moves interest rates, the economic data don't immediately respond. The first few rate cuts, he said, were partly responsible for the uptick in economic data, but the most recent cuts are yet to have impact.
Bannister noted the impact this could have on stocks. The 10-year treasury yield is down to 1.77% from 1.94% in early November, but the federal funds rate is around 1.6% now, he noted.
The real Fed Funds rate -- federal funds rate minus inflation rate -- is zero. And when the real rate is zero, the S&P 500's average forward price-to-earnings multiple should expand to 19.25 times expected 2020 earnings. Currently, the multiple is roughly 17.5, which some call fairly valued and others call slightly overvalued. Nonetheless, lower rates increase the present value of corporate cash flows.
UBS's Global Wealth Management team wrote in a research report that "in 2020, we forecast equity earnings to increase by around 5% in the U.S."
But while Bannister sees significant upside to cyclical stocks, UBS favors more defensive dividend stocks. And that's not only because UBS advises avoiding volatility, but also because dividend yields are at a premium compared to government bonds.
"In the U.S., we position our Dividend Ruler strategy with a bias toward higher-yield, higher-quality companies compared to the overall market," the Swiss bank said.
Some stocks currently yield dividends of more than 5% in the U.S, putting the treasury market to shame.