Outlook 2019: Stay the Course

Chief Investment Officer Neil Hennessy discusses recent volatility in the markets, and why he believes that the strong fundamentals still in place should reward long-term, level-headed investors who stay the course in 2019.

December 2018

  • Neil J. Hennessy
    Neil J. Hennessy
    Chief Investment Officer and Portfolio Manager

The U.S. stock market spent much of 2018 reaching new highs. Investors were happy with the Tax Reform bill and its effect on corporate profits and were looking forward to another year of strong economic growth and gently rising interest rates. Nonetheless, here we are in December, and as I write this, we are experiencing the market’s 20th downturn since 2010, one that has wiped out all the gains for the year, which started off so promisingly.

But, a correction does not necessarily signal the end of a bull market. Our banks are in great shape and high employment means people will continue to spend, save and invest. Markets bounce back. In the past, I have likened the current bull market to that of 1982-2000, and I still believe this comparison holds true.

What makes me feel optimistic? First, stock valuations today look compelling. The S&P 500 Index is trading at 15x forward earnings, a 12% discount to its five-year average and down from 20x at the start of the year. Moreover, earnings are still growing. Earnings per share (EPS) for the S&P 500 is expected to be up 33% in 2018, and forecasters have set the bar for 2019 at 8%, a number companies could potentially beat.

A major factor driving stock prices down has been the fear that rising interest rates will trigger a recession. I believe the Federal Reserve will take care not to raise interest rates too far or too fast and endanger the economic expansion. Wages have certainly been rising faster this year – at just over 3% in November. However, other measures of inflationary pressure, such as the Consumer Price Index and the Producer Price Index, still show prices increasing right in line with the Fed’s target, close to 2%. Low inflation means that the Fed won’t have to raise rates abruptly, and possibly may not have to raise them much higher than their current level. Reports of corporations scaling back on their investment plans as a result of uncertainty over trade will also temper Fed actions. Frankly, so will volatility in the stock market.

Cash, meanwhile, continues to build up on corporate balance sheets. The companies in the S&P 500 Index reported a total of over $5.4 trillion in cash and marketable securities in their latest filings. Companies have also been returning capital to shareholders. S&P 500 Index companies announced $433.6 billion in share repurchases during the 2nd quarter of 2018, nearly doubling the previous record of $242.1 billion in the first quarter.

Finally, most investors would agree, there are no signs of euphoria in this market. Yes, there was enthusiasm earlier in the year, following the reduction in corporate tax rates. But, in our opinion, it did not qualify as market-top euphoria. The financial headlines give the impression that all is doom and gloom, even though the fundamentals are, in our opinion, still strong. And now investors are beside themselves with anxiety over weakness in the real estate market, foreshadowing recession, and a tight labor market, along with higher costs due to import tariffs, slicing into profits. Fear has taken over.

As fear is high and people are scared, investors are not looking at the total picture. We have always believed that patience and time in the market are key to investing successfully, even through difficult periods. With strong fundamentals still in place, we are confident long-term, level-headed investors who stay the course should be rewarded over time.