The S&P 500 is Hitting New Record Highs…Actually, We’re Just Back to Where We Were Last Fall
May. 6, 2019 Commentary

The S&P 500 is Hitting New Record Highs... Actually, We're Back to Where We Were Last Fall

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“As long as the roots are not severed, all is well. And all will be well in the garden. Growth has its seasons. And yes, there will be growth in the spring.” - Peter Sellers as Chauncey Gardiner in the 1979 movie classic, “Being There”

Indeed these record highs that we’re seeing in the Standard & Poor’s 500 index inspired me and my son to watch that Peter Sellers/Shirley MacLaine classic movie, “Being There.” This film may not carry the economic and market poignancy of such other hits as “The Big Short” or “Wall Street”, but there are lessons to be gleaned, and it provides comic relief in the midst of this political drama we are experiencing. 

In the movie, Chauncey, who has been a gardener for an aristocratic family all of his adult life, somehow is thrown into the world of powerful socialites and becomes sought after by the president of the United States and world leaders who interpret his harmless and pointless statements about gardening as brilliant allegory about how to solve all the ills in the economy. Via a twist of fate, he may actually be catapulted into the Oval Office. No spoilers here. I’ll leave it to you to watch and find out how this all ends…it’s quite a satire. 

All Chauncey is truly capable of talking about is the garden…he knows nothing about finance. As it pertains to 2019 and the here and now, Chauncey was right about one thing…there is definitely growth in the spring. Importantly, the growth isn’t just in the price of stocks. It’s deeper and more fundamental than that. The economic and earnings recession that many (present company excluded) saw as imminent back in December 2018 isn’t anywhere to be found. As we anticipated, both the economy and corporate earnings are having a very nice spring. The roots weren’t severed after all, but remained in good health.

Those projected negative earnings results in the first quarter of 2019 now look to come in at positive levels. With about 50 percent of S&P 500 companies having reported Q1 earnings as of this writing, roughly 80 percent (higher figure than normal) have beat expectations, by a magnitude of 5 percent. It appears S&P 500 earnings are likely to grow 2-3 percent to start the year.1 Not great, but positive and better than feared. And, they did so in the midst of elevated trade rhetoric, government shutdown, handwringing over what the Fed was thinking at the time…and an associated pause in confidence. 

Revenue growth has averaged a better than expected 5 percent in the first quarter as well. Earnings growth expectations for 2020 have now risen to 11 percent.1 Turning to the economy, the first quarter gross domestic product (GDP) advanced by 3.2 percent,2 well above the very low expected pace that had a mere 1 percent handle on it going into the quarter*. There are some things in the first quarter GDP number that might not be sustainable, but there are good signs that other sustainable factors are likely to kick-in as we move through the year. We believe this will keep 2019 economic growth steady and above the low expectations that had developed. 

Retail sales were robust in March, consumer confidence remains strong, business confidence has stabilized and bounced a bit, purchasing managers data for manufacturing and service companies remain healthy and in growth mode, and there are signs of stabilization in housing and autos.3 Importantly the Chinese economy, which has influence on global growth, seems to be signaling a bottoming and soft landing rather than the hard landing that was feared. So, for now, the headlines have shifted from “Worst December Since 1931” back in late 2018 to “Best Start to the Year Since 1998” at the end of March and now to “The S&P 500 Hits Record High” in late April.2 Some may have thought we’d lost our minds when we expressed our positive views, based on our research and the key data metrics we monitor, about 2019 at the end of 2018. The major question now is: Where do we think the U.S. equity market will head from here? Read on. Spoiler alert: I think you’ll like what we’re thinking.

Where To From Here? 

With the headlines stating that the S&P 500 has broken through resistance and pushed to all-time highs at the end of April, it’s kind of implied in those articles that we’re at frothy levels and have gone into a space orbit of sorts. In other words, they suggest gravity will take hold and that elevated stock prices need to come back to earth…at least its logical that this is a question on investors’ minds right now after such a great start to the year.  

Quite frankly, we would turn this logic on its head and suggest that we’ve just come back to earth from overly pessimistic market levels and misguided conclusions of imminent recession at the end of 2018. Yes, the market is up 17 percent  or so in the early goings of 2019, but that is making-up for the almost 20 percent4 swoon on an intra-month peak to trough basis in December. Valuation had become enormously attractive in our eyes at 14 times earnings at the end of last year, and quite a few high-quality stocks were priced at half that multiple or thereabouts. Further, it has not been a v-shaped move to regain the highs…it took 145 trading days or more than six months to do so.5 We’re just now back to approximate levels we were in mid-September of 2018. For stats junkies, the table below shows that in the 24 times since 1950 that it has taken more than six months (125 trading days) to achieve a new 52-week high after a pullback, the market is up on average 13.1 percent in the ensuing 12 months (250 trading days) and the S&P 500 return is positive 95 percent of the time in those periods…not bad. 

S&P 500 Forward Performance Following 1st New 52-Week High in 6+ Months

Source: Strategas

That said, we don’t expect the market to move forward and rhyme with history merely because of these stats. We expect further advancement in the market based on positive fundamentals, reasonable valuation and the confidence building type of leadership we see in the U.S. stock market. Of course, this includes the caveat that we expect such positive returns to be accompanied by normal volatility and bumps along the way. On the fundamentals, we’ve already discussed the solid economic and earnings trends. Did we mention the healthy liquidity in the credit markets and low inflation? Valuation at roughly 16 times4 forward earnings is fair to attractive for these low levels of rates and inflation. Regarding the technical picture, leadership is decidedly on the cyclical side of the ledger at this juncture with the technology, consumer discretionary and industrial sectors by far representing the outperforming sectors post the late December swoon…a good technical sign for future market direction, in our opinion. 

Policy Outcomes Continue to Trend Nicely/Better Than Feared

Add to this some better outcomes on the policy front, both Fed and trade, and the calculus looks pretty good to us. In fact, the trade deal sounds like it could be better than consensus expectations, if a deal is struck. Per political analysts we talk with, U.S. Trade Representative Robert Lighthizer is proving to be a shrewd trade negotiator and winning respect on both sides of the aisle. It sounds to us that this is more than just getting a deal done and the Chinese buying a few more agricultural and electronic products from us; the Chinese appeared to have been making some key behavioral adjustments here, prior to the weekend just before President Trump’s tweets and the resulting tense rhetoric between U.S. and China representatives the week of May 6. If a deal is reached, the administration’s threats of higher tariffs earlier this year should result in significantly lower tariffs, which is good both for global growth and investor confidence. While frustrating, we must applaud Trade Representative Lighthizer and Company for insisting on strong enforcement mechanisms to ensure the trade deal has teeth and is not just cosmetic. If no deal happens, it would be a disappointment and cause us to modestly lower our S&P target for the year, but the economy and the market is far better poised to absorb this setback now than last December, from our perspective. It would not derail our positive longer term outlook. All that said we look for cooler heads to prevail and an agreement to be inked. 

Final point we’d make: There is a reason the year after a mid-term election and the third year of a presidential cycle tends to generate above average returns…see the chart below:

S&P 500 Price Return 12 Month Period Following Mid-Term Election

Source: Strategas

The rationale for this is pretty straightforward and self-preservation oriented. There is a huge incentive for the party in the White House to maintain a strong economy and advocate for ample stimulus. A trade deal would indeed serve as nice stimulus and sync with re-election goals. Some truly unexpected stimulus could come from renewed bipartisan discussions on an infrastructure deal. It’s too early to comment in a serious way on this, but there are some sparks in the ashes that would add to potential for nice fiscal stimulus surprises prior to the election. Going back to 1946, we’ve never seen a negative year in the S&P 500 in the calendar year following a mid-term election, plus the average return falls in the double digits.

OK, Maybe We Can’t Call it an Earnings Recession, But It’s still a Slowdown — Isn’t that a Concern?

Our take on this…embrace a moderate growth level or slowdown in earnings growth. The market has experienced some of its best years/decades when this has occurred. Goldilocks-type growth is outstanding for stocks and that is what we see here…not a profits recession or earnings decline but simply a soft landing or modest slowdown.

To wit, glance at the data in the table below. The 1950’s and 1980’s were nice examples of goldilocks periods for earnings and absolutely marvelous decades for S&P 500 returns. In both decades, annual compounded growth in earnings of 5 percent was below average, yet the S&P 500 returned 18 percent and 17 percent annually in those two decades. In both of those periods, P/E multiples rose significantly as investors bid them up, given the comfort provided in steady, grind-it-out earnings growth and expectations that rates and inflation would remain well contained as a result. Sound familiar? Contrast this to the 1970’s when annual earnings growth doubled and rose to the 10 percent level from the 1950’s and 1960’s pace of a mere 5 percent. That was good for stock prices, right? Not so! Annual compounded S&P 500 returns in the 1970’s fell to a below average level of 5 percent annually as investors fretted over earnings growth that was too robust and the rapid rise in inflation that could accompany such growth. P/E multiples were cut in half. So, let’s be careful what we’re wishing for. Per the data below, steady as she goes often wins the race. 

Table showing 1950's growth through March 2019

Source: Factset & Mariner Wealth Advisors' Research

Wrap-up

To conclude, our headline would not be, “S&P 500 Hits All-time Highs” and instead would read, “Back to Where We Should Be” on the progression line. We just recovered from a normal correction which generally allows us to reset and see where the economy and earnings trends truly are. These periods keep us humble and respectful of risk. We don’t see signs of recession but instead believe steady (not robust) trends continue. And this is a good thing.

 

1Factset & J.P. Morgan Q1 Earnings Season Tracker April 26

2Wall Street Journal

 *Federal Reserve Bank of Atlanta – GDPNow Estimate

3Factset & Strategas

4Factset

5Strategas

The S&P 500 Index is a market-value weighted index provided by Standard & Poor’s comprised of 500 stocks chosen for market size and industry group representation. 

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