Near the end of 2018, U.S. stock prices dropped more severely than seemed justified given the still-positive outlook for the fundamentals of economic and earnings growth. In our view, stocks have become more attractive and the pullback may have helped extend the bull market by lowering expectations. When the fundamental outlook has remained positive, pullbacks have been an opportunity for investors to add stocks at lower prices when appropriate.
Solid fundamentals –We expect slower but above-average economic and earnings growth in 2019, which should support rising stock prices over time. Optimistic consumers, solid job growth and relatively low interest rates support rising consumer spending. Despite concerns about higher costs, companies seem to be finding ways to keep margins and profits high. And a resolution of trade and tariff tensions could improve prospects for cyclical and trade-sensitive sectors.
Better valuations make large-cap stocks attractive – In 2018, the S&P 500 dropped 6.2%, while earnings rose more than 20%. We expect earnings to increase 7% to 8% in 2019, a slower but above-average pace. As the chart shows, the S&P 500’s forward P/E fell to 15.3x, its most attractive valuation since 2013. Stocks are no longer expensive, with the P/E well below their 16.7x average over the past 28 years. In addition, large-cap stocks have had above-average returns following past years when they’ve declined while earnings rose.1
Bear market in smaller U.S. stocks – Small- and mid-cap stock prices were down 22% and 27%, respectively, at their Dec. 24 lows, putting both into bear markets. Improved valuations and our expectations for rising earnings make them attractive relative to large-cap U.S. stocks. Although smaller stocks are more volatile than their larger counterparts, they have also have had higher long-term returns, compensating investors for the higher risk.2
The sharp stock market pullback, including a bear market in smaller stocks, has improved equity valuations but also is a reminder that stocks are volatile. Consider your comfort with volatility and long-term goals as you determine the appropriate equity investments to add to your portfolio.
1 Source: Bloomberg, 01/01/1987-12/31/2018, S&P 500. Past performance is not a guarantee of what will happen in the future.
2 Source: Morningstar Direct, 12/31/2018. Past performance is not a guarantee of what will happen in the future.
Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal.
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