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Stock Market Outlook for the Remainder of 2019
This Is What Volatility Looks Like
The past twelve months show a perfect example of why it’s impossible to time the stock market consistently.
Return from year ago, June 1, 2018 5.7%
Return from the Oct 3rd peak -1.8%
Return from the Dec 24th low 21.6%
Year to Date return 14.0%
Return from April 30th peak -3.6%
If you had been in the stock market for the past year, it would have felt very uncomfortable. Yet, the return for the last twelve months was +5.7%. For investors who panicked in December and sold, they missed a +14% gain year-to-date from January 1st.
Although it’s impossible to time the stock market, that doesn’t stop us from wanting to better understand what we could expect going forward -- especially if we have cash to invest. Let’s first take a look at the stock market and then review bonds.
Corporate Earnings Forecasts Are Not Aggressive
In sharing our stock market outlook for the remainder of 2019, we look at forecasted earnings as a guide of what to expect from the stock market. Currently, Wall Street analysts are forecasting flat earnings growth for companies until the last quarter of the year.
The chart above shows earnings growth that has been reported through the first quarter 2019 plus what is expected for the rest of 2019 and for 2020. The big growth numbers in 2018 were a result of the corporate tax cut enacted early last year.
Those tax cuts flowed directly to the bottom line.
Notice the declining growth in the last quarter of 2018. It should have been another quarter with more than 20% earnings growth.
However it appears -- in hindsight -- that the threat of tariffs caused companies to add to their inventory during the first three quarters of 2018. During that time, earnings growth benefited from an increase in sales as a result of inventory buying and not just the tax cut.
Spending on inventory dropped in the fourth quarter.
Risks to The Forecast
The trade war and resulting uncertainty over tariffs had a slowing effect on sales outside of the US. And most of the companies in the S&P 500 index have significant international businesses. The bump up in growth that is expected at the end of 2019 is partially due to the easy comparison versus last year, and partially the expectation of spending from pent-up demand in 2020.
A worsening trade war is the biggest threat to the upbeat earnings forecast for the end of 2019. We are watching this closely. If the trade war doesn’t escalate, then we anticipate that a strengthening of the stock market will start late in the summer and continue into next year.
In our midyear outlook, we expect the stock market to be choppy until at least late July or early August.
The Bond Market Is Worried…As Always
Switching our focus to the bond market, we monitor the change in the yield of US Treasury bonds that mature in ten years (aka 10-year Treasuries) to gain insight into bond investors’ view of the economy.
Higher yields imply that investors are worried about inflation. Lower yields imply that investors are worried about a recession.
The chart above shows the change in the 10-year Treasury yield since the Financial Crisis in 2008. You can see the low yields in 2012 and 2016, each of which coincides with concerns about an economic slowdown. Yields fell to 1.46% in 2012 and 1.36% in 2016.
As a comparison, the current yield is 2.1%.
Our interpretation of the current low yield is that bond investors are worried about slowing growth and a possible recession. But they aren’t as worried now as they were in 2012 and 2016 so we will watch to see if yields continue to fall.
Yields In Different Maturities and Quality
In addition to the current bond yield, we also look at the comparison of yield over different maturities and between different quality ratings of bonds.
In the chart above, you can see that yields are nearly unchanged until maturities reach greater than five years. Most of the time, a bond that matures in five years would have a higher yield than a bond that matures in three years. A bond maturing in three years would yield higher than a bond that matures in two years, and so on.
It’s unusual to see the maturity/yield relationship so flat.
The US Treasuries yield of different maturities (aka yield curve) actually falls slightly at 2 year, 3 year and 4 year maturities until it starts to rise again. This doesn’t occur frequently and can be an early sign of recession.
Our expectation for the rest of the year for the bond market is that if the economy slows down over the next several months, then the Federal Reserve will lower the overnight interest rate to try to stimulate spending.
There is downward pressure on rates in the near term.
But if we see corporate earnings pick up near the end of the year, we do believe that rates will start to climb again. Again, the big unknown is what will happen with tariffs and trade.
The Stock Market In The Next Seven Months
We predict that the stock market will be choppy this summer (net flat) and strengthen into the fall. We predict bond rates will remain low and begin to increase in the fall. As mentioned above, the biggest risk to both stock and bond scenarios is new tariff announcements.
At Archer Bay Capital, we believe we need to weather the volatility, focus on long term investment goals and…enjoy the summer! Contact us to learn more about stock market outlook for the remainder of 2019, or to schedule a consultation today.