Stocks have climbed strongly since late December, which gives us pause as we consider the near term prospects.
Provided that the economy does not slide into recession, we think equity prices can still rise in 2019.
But we think volatility will remain relatively high given lingering uncertainty.
The equity rally continued last week with stocks rising for a fourth consecutive week, thanks to an ongoing sense that trade issues may be receding and a more dovish outlook for federal reserve policy. The S&P 500 index rose 2.9% and is up close to 14% since its low on December 26th. As long as the U.S. economy doesn't enter a recession, we think corporate earnings should remain good enough to provide additional upside room for stock prices in 2019. But given the extreme technical damage done to the market during the fourth quarter, we think volatility may remain elevated and expect to see high diversion between relative market winners and losers.
Weekly Top Themes
- Corporate earnings growth is likely to slow in 2019. With 13% of S&P 500 companies reporting fourth quarter results, earnings are ahead of expectations by an average of 1.7%, compared to an average of 4.9% over the last three years. We still expect positive earnings growth this year, but think the pace will be slower than in years past.
- We expect stock prices can climb this year, but the pace of the recent rally gives us pause. About a month ago, when stocks were at their low, we suggested prices might be at an inflection point. Likewise, given the strong pace of gains over the past 4 weeks, we think investors should approach the near-term cautiously and think gains may be harder to come by.
- Consumer sentiment appears to have taken a recent hit. The University of Michigan's index of consumer sentiment dropped sharply from 98.3 in December to 90.7 this month. We think concerns over the government shutdown, confusion over tariffs, equity market volatility and monetary policy uncertainty are causing sentiment issues.
Reasons to Remain Constructive
Stock prices have rebounded strongly to start the year. Our longer-term view remains that stock prices could have further upside as long as economic and earnings growth remains positive. Our constructive view is based on the following assumptions:
- Recession risks are overstated, even if growth is likely to slow this year.
- Corporate earnings growth may slow significantly in 2019 as the effects of tax cuts fade but should remain in positive territory.
- Improved valuations provide more of a floor for stocks. Since the lows in December, the forward price-to-earnings ratio on the S&P 500 has climbed from 13.5x to 15.5x, which is still below last year's high of 18.5x.
- Negative sentiment remains a positive contrarian signal. We think many investors are still skittish about the stock market and are keeping cash on the sidelines waiting to invest.
Investments Positioning in an Uncertain Environment
Over the near-term, we think volatility is likely to persist, as a number of risks remain that have been putting downward pressure on investor and consumer sentiment. The fact that we are later in the economic cycle also means that equity market gains may be uneven and more difficult to achieve.
So what does that mean for investment positioning? We think the most attractive areas of the market are those companies with relatively strong balance sheets, high levels of profitability and greater cash flow consistency. From a sector perspective, this leads us to favour technology and health care, with financials being our favourite value sector.
The author of this article is Marcus Queree, Partner & Director of DNA Wealth. Any information herein is only expressions and opinions. This document does not constitute an offer, an invitation to offer, or a recommendation to enter into any transaction, nor does it constitute investment advice. The information contained herein is confidential and reproduction of any part of this material is prohibited. If you are in any doubt as to the suitability of an investment you should always consult your financial adviser. DNA does not receive any form of compensation for circulation of such material.