2019’s gains were among the strongest of the 2000s and well outpaced our expectations. We don’t think this exhausts the bull market’s tank heading into 2020, but it does temper our expected return for the coming year. Modest earnings growth and full valuations should drive more moderate gains this year, but the strong year-end rally sets the stage for a potentially rockier start.
Market may take a breather – Stocks rallied sharply heading into this year, and we think there is now an air of complacency in the market. We think an uptick in volatility, and a short-term pullback, is a reasonable expectation. And we think 2020 is likely to endure more frequent swings, as was the case in 2016 and 2018, when election and trade uncertainties rose.
The bull isn’t exhausted – We don’t think pullbacks will give way to a bear market, as the conditions that are historically associated with a bear market are not in place. Economic growth should continue to offer support to the market. In the 16 years since 1950 in which unemployment was below 4.5% heading into year-end (currently 3.5%), the average S&P 500 return in the following year was 9.9%. Past performance is not a guarantee of what will happen in the future.
More moderate gains ahead – 2019’s sizable returns won’t likely be replicated this year, in our view, but since 1950, when the S&P 500 rose by more than 20%, the average return in the next year was 11.27%, indicating great years don’t have to be followed by bad ones. Stocks enter 2020 with valuations slightly above long-term averages. But to us, there is limited potential for material expansion in the price-to-earnings ratio from here, meaning the pace of market gains will be set by the pace of earnings growth.
Sharp stock gains offer a timely opportunity to rebalance to your long-term target weight in equities. Pullbacks would offer a compelling buying opportunity. An extended economic expansion supports the case for appropriate allocations to U.S. small-caps, while a slightly better global outlook and discounted valuations support our ongoing favorable view of international equities.
Investing in equities involves risk. The value of your shares will fluctuate and you may lose principal. Small-cap stocks tend to be more volatile than large company stocks.
Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.
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