The US stock market is struggling to hold above the flat-line in 2018 after being up double-digits at the end of the third quarter. Investors are now worried about a global economic slowdown ending the bullish phase of the US stock market. What is AlphaProfit’s US stock market forecast for 2019?
The US economy has fared well in 2018.
The unemployment rate has declined to 3.7% from 4.1% at the start of the year.
Following a relatively slow start, the US gross domestic product grew at an annual rate of 4.2% and 3.5% in the second and third quarters, respectively.
Corporate earnings have benefited from lower income tax rates and US economic expansion. S&P 500 member earnings have grown over 25% year-over-year in each of the first three quarters of 2018.
The Federal Reserve continued raising benchmark interest rates to curb monetary stimulus deployed to combat the Great Recession.
The central bank raised its benchmark federal funds interest rate four times in 2018. The federal funds rate now stands at 2.5% after starting the year at 1.5%.
Popular large-cap benchmarks, the S&P 500 and the Dow Jones Industrial Average are, however, down 4.4% and 5.6%, respectively while the small-cap Russell 2000 benchmark is down 11.0%.
Although inflation and trade war fears rocked US stocks in the first quarter, they bounced back. Strong earnings boosted investors’ appetite for risk and enabled stocks to rally during the second and third quarters.
Stock prices have tumbled in the fourth quarter. Escalating trade tensions with China and worries of rising US interest rates sapping economic growth have risen to the forefront.
Investors are risk averse as 2018 draws to a close. Defensive sectors of the market have held up better while economically sensitive sectors and small-caps have fallen out of favor.
US Stock Market Forecast for 2019: What’s on Investors’ and Analysts’ Minds?
A recent survey conducted by State Street Global Advisors shows investors are most concerned with the following issues: global economic slowdown, geopolitical and international trade tensions, and end of the US stock bull market.
One-off factors like a reduction in corporate tax rate are no longer available to boost year-over-year growth in earnings. Earnings growth in 2019 is likely to fall to a ‘normal’ level from the abnormally high 21.6% likely in 2018.
According to FactSet, analysts currently expect S&P 500 companies to grow their earnings per share to $175.94 in 2019 from $162.32 in 2018. This implies an EPS growth forecast of 8.4% in 2019.
Nearly half of the earnings growth is expected to result from economic growth. Inflation and share buybacks are expected to drive the other half.
US Stock Market Forecast for 2019: Key Risks to Stock Prices
Major economies around the world are slowing now in contrast to the synchronized growth evident at the start of 2018.
Among them, the US is farthest along in the economic cycle. Its growth rate, however, appears to be slowing.
Although European economies are earlier in the cycle, their growth rate has been slowing since the fourth quarter of 2017.
Partly weighed by US tariffs, China’s economy has slowed materially in the later part of 2018 and its outlook is worrisome.
Trade-related uncertainties and the Federal Reserve’s interest rate policy add to worries of the global economic slowdown pushing the US into recession.
The danger of a trade war between the US and China will resurface particularly if negotiations fail to resolve sticky trade issues before the end of the 90-day ‘cease-fire’ period on March 1 and new tariffs come into play.
The Federal Reserve is raising benchmark short-term interest rates on the back of strong job creation and stable inflation. The central bank expects to raise interest rates two more times in 2019. The Fed is also tightening financial conditions by shrinking its balance sheet by $50 billion a month, effectively reversing the stimulus it provided during and after the financial crisis.
The risk in this is the Federal Reserve may tighten monetary conditions too much against a weakening global economic backdrop and tip the US into recession.
So, what does this all mean for AlphaProfit’s US stock market forecast for 2019?
US Stock Market Forecast for 2019: Bottom Line
Historically, stock market returns tend to be lower when the starting forward 12-month price-to-earnings ratio is elevated.
Going into 2018, the forward 12-month P/E ratio was highly elevated at 18.3. This left little room for the P/E ratio to increase, despite US companies exceeding earnings expectations this year.
Stocks are likely to start trading in 2019 with a modest forward P/E ratio. The S&P 500 closed on December 19 at 2506.96, implying a forward P/E ratio of 14.2. This compares favorably with the P/E ratio’s 5-year and 10-year averages of 16.4 and 14.6, respectively.
Gains for the US stock market can match the magnitude of growth in earnings in 2019 if US companies match or exceed earnings expectations and valuation metrics do not change materially. This scenario would imply a solid single-digit return in 2019, better than where US stocks currently stand in 2018. This outcome is likely if trade-war and interest rates concerns do not get out of hand.
On the downside, disappointment in earnings growth can lead to a contraction in the forward P/E ratio. US stock prices would decline by 12% if the forward P/E ratio were to drop one-standard deviation below its 10-year average to 12.5.