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Last year, US stocks had their best year since 2013: the S&P 500 Index rose more than 30% in dollar terms (25% in sterling terms)*. Can we expect the same this year? Or is it time to bag some profits?
According to Goldman Sachs, there remains a strong case for staying invested in US companies. Goldman’s chart of the week** shows that historically, when the S&P returned greater than 30% over a one-year period, 85% of the time the subsequent year also saw positive returns. In fact, the average return was 10.4%, greater than the average 8.5% that the S&P generated in any given one-year period.
Source: Goldman Sachs Investment Strategy Group, Bloomberg and GSAM
Nick Ford and Hugh Grieves, managers of LF Miton US Opportunities agree. “Historically, years with similar annual gains are typically positive the next year,” they said. “The U.S. presidential cycle heavily favours third years (2019), with fourth years still being positive, but more moderately so.
“History has also shown that after an annual gain of 20% or more, the following year is up 8% on average and is positive two thirds of the time. This year’s market performance has made the current bull market, defined as an up market without a correction of 20% or greater, the fourth longest with the fourth largest gains of the past 120 years.
“If the U.S. Federal Reserve remains accommodative, interest rates and inflation stay low, and earnings continue to rise, we believe it is likely that the present bull market can continue for at least another year.”
Rathbone’s Julian Chillingworth says that an improvement in company earnings and accommodative interest rates will be necessary for the stock market to continue to do well: “Company analysts and economists are hoping that the measures agreed in the phase-one trade deal between the US and China will lead to an uptick in economic growth, which would then flow through to greater company profits,” he said. “If stock markets are to hold on to their 2019 gains, this improvement in company earnings will be crucial.
“Another important factor is interest rates. As we enter 2020, virtually all forecasters expect the US Federal Reserve to keep its monetary policy steady. All things being equal, lower interest rates mean higher stock prices because interest rates are used today to put a dollar value on all those profits that companies are expected to make in coming years. The lower the interest rate, the more value you put on those future profits; the higher the interest rate, the less value.”
Lazard Asset Management, home of the Elite Rated US Equity Concentrated, is also positive. “The US economy appears to have averted recession and could continue to grow through 2021, albeit at an uninspiring pace,” commented a spokesperson.
“We acknowledge that US equities are by no means inexpensive relative to history, but also point out that US economic and earnings outlooks are the most resilient of major developed markets, while returns on capital in the US are about 50% higher than in Europe and double those in Japan. Over time, US companies have demonstrated an ability and willingness to manage on behalf of shareholders. In our view, these factors warrant a higher valuation than other markets.”
“After a record-setting year, we still see upside for US equities in 2020. The biggest risks to the US economy a year ago were an over exuberant Federal Reserve, an escalating trade war, and a global industrial deceleration. The Fed has clearly removed itself as a risk factor (it is no longer raising interest rates), the US-China situation has de-escalated for now, and the industrial economy is showing potential early signs of stabilisation.
“Against this backdrop, we believe S&P 500 companies are likely to achieve mid-single digit earnings growth. Assuming no valuation expansion or compression, that would lead to a base case expectation for mid-single digit gains in US equities. If we are wrong, we think it is likely that we are not optimistic enough regarding US equities, as earnings could be stronger and ultra-low interest rates could lead to further increases in valuation – and possibly another year of double-digit returns on US equities.”
*Source: FE Analytics, total returns in US dollars and sterling, calendar year 2019
**Source: Goldman Sachs Market Monitor, 10 January 2020