By Tim Courtney, Chief Investment Officer
There’s no doubt 2018 has been an odd year for the stock market. Fundamentals that typically indicate great market health haven’t led to great performance. Among positive developments were corporate operating earnings of about $157, making 2018 the most profitable year ever for S&P 500 companies.1
Most analysts expected growth this year as a result of the tax reform bill passed in late 20172, but the sheer scale of that growth has surpassed expectations. This year’s strong corporate earnings provide a great foundation for market health moving forward, and U.S. gross domestic product (GDP) growth will probably come in at a solid 2.5 to 3 percent for 2018.3 Based on household surveys, American consumers are also demonstrating high confidence in their financial situations.4
While many good things are happening, the market will likely end the year about where it started due to multiple stock market corrections.5 The lingering trade war between the U.S. and China6, along with the prospect of continued interest rate hikes from the Federal Reserve7, have caused significant investor uncertainty and subsequent market volatility. Additionally, tumbling commodity prices and concerns about slowing global growth contributed to adverse market reactions.8
Much of the good news in 2018 has been overshadowed by other issues. Looking at the overall numbers, we believe it’s likely the market has already priced in an upcoming recession. That could be the strangest aspect of 2018, because you wouldn’t expect the market to have so much downside volatility during a year where corporate profits jumped 25 percent.1
However, it’s important to emphasize that the market is not the economy and has not been a reliable indicator of recessions. Market corrections in 2010, 2011 (both of which approached 20 percent) and 2016 did not precede a recession.9 At least a mild recession is bound to occur eventually, whether it happens in 2019 or some other point in the future.
The most positive outcome of 2018 is the market has gotten cheaper. Despite the ups and downs, it’s reassuring that the market does not appear to be overpriced. The S&P is currently trading around 2,570, or about 18 times booked earnings and 16 times booked operating earnings.10 That’s not far from the long-term average and represents a very reasonable number, especially with interest rates hovering around 3 percent.11
2018 has certainly been an irregular year, and we would have expected to see less downward volatility amid positive economic fundamentals. There may still be a rally as 2018 closes out, but if not, we enter 2019 with a very reasonably priced market. That makes us less worried about the effects of a possible recession because it appears much of the effects of a recession are already baked into prices.
1. Refinitiv – S&P 500 earnings dashboard / Dec. 6
2. CBS News – Here are the details of the final GOP tax bill
3. Kiplinger – A good third quarter, but a slowdown is ahead
4. Reuters – U.S. consumer confidence races to near 18-year high
5. Money and Markets – What makes the 2018 stock market corrections different?
6. Forbes – Trade war update: China subverts tariffs, trade gap gets wider
7. Bankrate – The Federal Reserve pauses on raising rates – for now
8. OECD – GDP growth – Third quarter of 2018, OECD
9. MarketWatch – Here’s a reminder that stock-market corrections don’t always become bear markets
10. CNN Business – S&P 500 Index
11. MarketWatch – Today’s interest rates
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