During the fourth quarter, stock prices rose throughout the world, with the U.S. market and international markets both returning approximately 8% including dividends.Jan 2020
Interestingly, the drivers behind this performance – hopes for a trade war resolution, continuing economic growth, and persistently low interest rates – were essentially a mirror image of those driving last year’s fourth quarter market meltdown. As we look toward 2020 and beyond, we see these same themes as central to the performance of stocks worldwide.
Looking at 2019 overall, global stock market performance was quite strong. U.S. stocks delivered a total return of 31.5%, which is quite remarkable
given that we are in the 11th year of an economic recovery. Interestingly, U.S. corporate profits have grown only 1% in 2019 (final results are due by March). In this light, it makes sense why many investors are concerned that stock prices have gotten ahead of themselves, and that a pullback in prices could be imminent. We believe it is more helpful to view 2019’s market rally from a longer-term perspective.
First, it is impressive that 2019 earnings grew at all as the 1% corporate earnings growth in 2019 was on top of tax cut-fueled 22% growth in 2018. Second, looking at the last two years as one period of time, average annual earnings growth was ~11% while the average annual market total return (price appreciation plus dividends) was ~10%. Third, the current valuation S&P 500 Index appears reasonable at 19.8x 2019 earnings per share of $163. In fact, this is below the 20.6x multiple the market commanded at the beginning of 2018, though above the 17.4x trough at the end of 2018.
Compared to a longer history and the present interest rate environment, valuations appear reasonable, even if they are above long-term trends, telling us it is all about corporate earnings growth from here. As discussed above, we continue to expect positive, albeit subdued, economic growth in 2020. As such, we would not be surprised to see the U.S. stock market continue to march higher, notwithstanding the occasional and inevitable pullback driven by any number of headlines (trade, politics, weakness abroad, etc.). All of this could be exacerbated by investors’ trigger-happy tendencies to sell this late in the current bull-market.
As we wrote in our third quarter commentary, recent stock market strength has disproportionately benefited certain types of stocks – namely those viewed to be higher quality, less volatile, and that generate stable cash flows. In some instances, valuations for these stocks have reached excessive levels. We will continue recent efforts to trim positions where valuations appear stretched and/or position sizes have grown too large, rotating proceeds into stocks we believe are well positioned for the long-term but may have lagged in the recent quarters.
With regard to international markets, 2019 was a “sneaky good” year, with the MSCI All Country Worldwide Ex-U.S. Index returning roughly 22% despite aggregate corporate earnings on track for a mid-single-digit percentage decline. Increasing prospects for a trade dispute resolution, anything but a hard Brexit, and hopes for green shoots in major economies in Europe have helped sentiment. Valuation multiples still appear reasonable at about 15x 2019 EPS, and compelling when considering expectations for high single-digit earnings growth in 2020 and 2021. While the structure of stock markets outside of the U.S. (higher mix of Financial and Cyclical companies, lower mix of Technology companies) may account for some of the valuation difference with the U.S., there is potential for the valuation gap to narrow if U.S. growth slows and/or market sentiment outside the U.S. improves. Additionally, the U.S. dollar has been strong over the last ten years (see accompanying chart) and if it were to weaken because of better relative growth outside the U.S., that would provide a meaningful tailwind for international equity returns. The last time the dollar was weak relative to major currencies was in 2017 and international equities strongly outperformed their U.S. counterparts
over that period.
We firmly believe the long-term, secular trend towards globalization and growth of middle class populations across the world remains intact, despite intermittent and mostly temporary interruptions by events such as the recent trade war. We are mindful of the potential for increasingly protectionist tendencies further disrupting the globalization story, but not on a permanent basis. The long-term trend should prove to be bullish for international equities and we remain committed to the asset class and look to increase exposure opportunistically.