Each year, Wall Street comes out with their predictions and projections on where they think the market will go in the coming year. Although 2019 is not over yet, one analyst is already making forecasts on what we have in store for 2020.
It’s no secret that earnings are the primary determinant of the future of stock prices. However, recent years have definitely influenced investor behavior and the goalposts could be moving in terms of what to expect in 2020.
State Street’s Michael Arone suggests that investors aren’t behaving like earnings results are the only thing that matters for stocks. Instead, they are obsessed with what the Federal Reserve will say or do next about interest rates, the U.S.-China trade negotiations and whether President Trump will deliver a military strike on Iran.
So far this year, the S&P 500 Index has climbed slightly more than 21%, a solid return for investors. However, according to FactSet, earnings for S&P 500 companies are expected to decline 3.7% year over year through the third quarter.
If earnings do fall year over year in the third quarter, it would mark the third consecutive quarter of declines. This would be the first three-quarters earnings decline for the S&P 500 Index since the fourth quarter of 2015 through second-quarter 2016, further confirming the so-called earnings recession. Interestingly enough, earnings for S&P 500 companies rose by more than 20% in 2018, yet the index fell by about 4.5% for the year.
Arone detailed in his report:
It’s always been about evolving expectations, and investor behavior reflects that reality. The declining effectiveness of earnings models, the odd response to solid earnings from the health care sector and recent years’ stock market performance confirm it. In 2017, the S&P 500 Index returned nearly 22% because investors correctly anticipated a big jump in 2018 earnings from the huge fiscal policy package delivered by the Trump administration that year. And, earnings did rise more than 20% in 2018. Not surprisingly, stocks fell in 2018 as investors realized that 2019 earnings would be negatively impacted by temporary fiscal stimulus benefits, the Fed raising rates, rising trade tensions with China and tough year-over-year earnings comparisons. That brings us to 2019, and stocks have performed well thus far. Investors expect that a US-China trade deal, a more dovish Fed and easier year-over-year earnings comparisons will result in double-digit earnings growth in 2020.
Considering Arone’s logic and applying it to the outlook for stocks next year, stock market performance will largely depend on changing earnings expectations for 2021. After what is expected to be a solid year for earnings in 2020, the risks to 2021 earnings likely are skewed to the downside.
Of course, there are many things that could result in much better-than-anticipated earnings in 2021. But with many folks penciling in a US recession that year, I think the odds of disappointment are greater. And if the pattern of the past few years holds, it may be tough going for stocks in 2020.