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Written by: Ivan Martchev Most forecasts will turn out wrong, but since clients demand them, we have to do the best we can. Yet, most market-moving events are simply outside the scope or the capability of econometric models.For example, it does not look like there will be a recession in 2020, based on all available economic data and the current state of fiscal and monetary policy. Yet it is impossible to accurately forecast what Little Kim in North Korea will do in his role as “Rocket Man,” as President Trump so melodically dubbed him.Nor is it possible to forecast which tanker will explode in the Persian Gulf and when or what predator drones will strike at valuable infrastructure in order to stir up tensions there. False-flag attacks have been happening for millennia to instigate armed conflict. It probably won't stop in 2020, as it is part of history.A hot war in the Persian Gulf, combined with no Phase II trade deal with China, will definitely ruin what looks to be my previous “glass half-full” economic forecast for 2020. On the positive side, denuclearizing North Korea, as unrealistic as it seems, combined with peace in the Persian Gulf, and a good-faith Phase II trade deal with the Chinese will help the U.S. and the global economy big time.
If everything goes according to plan, the economy has excellent chances to re-accelerate, as there is a definite second-leg effect from major tax cuts, as evidenced by the 1986 Ronald Reagan tax cut as well as the 2003 George W. Bush tax cut. The December 2017 Trump tax cut should be no different, with the second-leg effect being felt in 2020. I would not put it past the Republican leadership and the President to have timed the tax cut with the 2020 election in mind, but that is what politicians inherently tend to do.Trump ran on a platform, which he mostly delivered. Based on those results, he will try to get reelected. As far as I am concerned, and I consider myself independent, the American public got exactly what they voted for, and the President did exactly what he said he was going to do in his election campaign.I may not agree with a lot of the things President Trump has done, or how he has done them, but on balance they have been good for the economy from the short- and intermediate-term perspective. That some are bad, from a long-term perspective, is not a consideration at this point.As John Maynard Keynes so eloquently pointed out: “In the long term, we're all dead.” 2020 S&P Earnings Growth May Be Up Almost 10%It is not very often you see a year in which the S&P 500 earnings are up more than 20%, as they were in 2018, while the index ended down 4.5% (with dividends reinvested). Then, based on present 4Q earnings estimates, 2019 earnings will be flat, yet the index is up almost 30% in 2019, as of this writing.The way investors need to look at this is that the weighted average of the combined two years (2018-19) for EPS growth and index performance is fairly normal. The volatility was the result of the epic clash of fiscal and monetary policy as well as the very serious trade tensions and the global geopolitical mess.
The EPS of S&P 500 companies with more global exposure is expected to grow at barely half the rate of companies with less global exposure, but that can change with a good-faith Phase II China trade deal.
Stocks trade on forward expectations. Based on that, we are getting expensive on the 5- and 10-year P/E averages for the S&P 500. Yet, reported earnings are real, while forward expectations are guesses. Expectations for 2019 EPS growth were 6-7% at the end of 2018 and we ended up flat in EPS growth, yet the index is up 30%. Expectations for 2020 EPS growth are nearly 10%, yet I think the chances that EPS growth ends up in the teens for 2020 are high, based on prior tax-cut patterns.
Based on reported “real” trailing EPS, the S&P 500 P/E is still not as expensive as it was at prior tops in the market. With no recession in sight, the stock market should be up modestly next year, but the risk is that it overshoots to the upside, as I believe the consensus EPS forecasts are too low.
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