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Higher Expected Earnings Available at a Lower Price -- What Do We See for the Year Ahead?

January 04, 2019
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Happy New Year! We hope you have enjoyed the holiday season and that this year brings happiness, health, and good fortune your way. Given the recent market moves, we want to share some updated thoughts with you at this time.

In October, we cautioned that there were some potential issues ahead while also reminding you that much of the economic data remained strong. The 4th quarter had quite a bit of volatility. Let’s quickly recap 2018’s market move and then turn our attention to where this has positioned us as we begin 2019. 

Stocks Finished the Year in Negative Territory

US Stocks     -6.24%

International Stocks2      -14.76%

Market Valuation – Looking at 2019

Now we find ourselves in early 2019 with a market level (using the S&P500) of 2565. The market is often labelled as ‘cheap’ or ‘expensive’ based on the multiple-to-earnings or P/E Ratio. Let’s look at this a bit further….

2019 Earnings Expectations for 500 largest US companies      173.63 points3

Current Market Level1      2565

The 1-Year Forward PE Ratio can be found by dividing the market level (2565) by total expected earnings (173.63). Currently the multiple is 14.77. For reference, the 25 year average is 16.1.4 We entered 2018 with a multiple close to 18, so the current valuation is considerably more attractive than it was at the beginning of last year and it is notably cheaper than its 25 year average. So what does this mean? If you liked the market at the beginning of 2018, you should really like it now.

This discount is occurring with a backdrop of strong economic data here in the US. Unemployment remains near all-time lows, consumer confidence is high, and GDP growth has been strong. We recognize that we are 10 years into a market expansion (low point was March 2009). The reality is that current data indicates there is not a recession around the corner. Data indicates that the economy will continue to grow for the next year.

International Landscape

The international markets are a bit cloudier.

In our recent client note, we brought your attention to two global issues. We’ll provide a short comment on each below:

(1) Italian debt issues. Since our recent note, Italy was able to get its budget approved by the EU. This isn’t a long-term solution, but it does pave the way for markets to move higher knowing that the short-term uncertainty is gone.

(2) Chinese trade disputes. This issue continues into 2019. China’s economic data softened over the 2nd half of 2018 and thus far their economy is showing greater impact than we have seen here in the US. This may motivate China to reach a resolution, but risk remains until the deal is done.

The market does not like uncertainty, and we face the reality of investing in an uncertain world. With this said, if a China trade deal is reached then this would remove uncertainty and we would expect a favorable market reaction.

So….what have we done and what are we doing?

In our managed models, we trimmed risk early in the 4th quarter. This helped preserve principal over the last 90 days of the year. Now, the market has presented us with an attractive valuation. If earnings are able to meet expectations for 2019, then we believe patience is going to reward investors. We are adjusting our managed models to take advantage of the recent sell-off that the market provided.

The Bottom Line: First, note that everyone has a different timeline and a different tolerance for risk. We are keenly aware of this and we take this into account when customizing your investment blend. If anything has changed with your cash flow or lifestyle, and you believe it may impact how we should manage your accounts then please let us know.

Also, if you see us referencing our managed models and you aren’t sure if your accounts are receiving the tactical adjustments then reach out. Some accounts are unable to be managed tactically due to scale or other constraints, but we’ll make an effort to get you on the managed platform if it’s something you want to do.

Sources:

1: S&P 500 Data
2: MSCI Allcap World ex US
3: Yardeni Research
4: Factset, JP Morgan Asset Management